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Thursday, May 24, 2007

Taxing Internet Access - A Bad Idea
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Congress is considering whether to allow a ban on taxing Internet access to expire.

Taxing Internet access would be a bad idea. Consumers remain sensitive to the price of broadband, and because taxing price sensitive goods can significantly reduce demand, taxing Internet access is likely to have a negative effect on subscribership.

Given Congress's recent hand-wringing about broadband availability and takeup it would be ironic if it were to endorse a policy sure to reduce broadband's growth rate.

Why would taxing Internet access have this negative effect?

Taxes should be collected in the most efficient way possible. From an economics perspective, that means taxes should be imposed in ways that have the least impact on consumer behavior. Taxes that cause consumers to change their behavior are generally harmful to the economy and our well-being (that is, they create "deadweight loss" unless those taxes are specifically intended to discourage harmful behavior).

Because tax mechanisms should avoid unintentionally changing consumer behavior, policymakers should exercise caution when imposing taxes on price-sensitive activities since price increases on such goods are likely to substantially affect demand.

Broadband remains price sensitive. Ken Flamm, an economist at the University of Texas, estimated in a 2005 paper an own-price elasticity of -0.22 for broadband. Other estimates estimate price elasticity to be much higher: around -2.**

Consumers would view new taxes on Internet access as a price increase, thereby reducing demand for broadband.

Taxes on telecommunications services in general have long been recognized as among the most inefficient taxes levied. Economists have argued for reducing these harmful taxes and raising required revenues through the general taxation system instead.

The old system of taxing telecom service was bad. Taxing Internet access while also calling for to increased broadband penetration would be contradictory, at best.

** NOTE: I have somewhat modified this entry in response to Greg Rosston's insightful comment. The paragraph above denoted with two asterisks (**) originally read:

Broadband remains quite price sensitive. Ken Flamm, an economist at the University of Texas, estimated in a 2005 paper an own-price elasticity of -0.22 for broadband. In other words, he found that a 10 percent increase in broadband price would reduce demand by 2.2 percent.

posted by Scott Wallsten @ 1:15 PM | Broadband , Economics , Taxes

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Shouldn't you compare the efficiency of the tax to the alternatives? for example, I was a bit surprised to see and elasticiy of -0.22 termed "quite price sensitive". Most of the work looking at telecom taxes compares taxing long distance which had an elasticity of -0.7 compared to the local service elasticity of about -0.01. Now, I agree that if you could tax things with elasticities of -0.01, that would be much better, but what is the alternative? If general income taxes would be used, i would guess that would be more distortionary than a tax on something with an elasticity of -0.22. Also would a tax exemption on one form of information and recreation distort efficient resource allocation away from other forms that are taxed causing more distortions? I think that these quesions need answering before you can make the conclusion that it would be "a bad idea."

Posted by: Greg Rosston at May 25, 2007 2:12 PM

Greg, thank you -- that's an excellent point. And you're right, -0.22 seems low. Other estimates put it at around -2 (which I've now cited above).

Nevertheless no telecom tax has, to my knowledge, ever been shown to be efficient relative to our other methods of raising taxes. It's unlikely that suddenly an access tax on a relatively new service would be. And regardless, it still contradicts the goal of increasing broadband penetration.

Posted by: Scott Wallsten at May 25, 2007 3:31 PM

That makes more sense. There is still a question about the "goal of increasing broadband penetration" and whether that should be a goal. But if it is, then taxing it would not make sense. However, this is the argument that got taxes on long distance instead of local connections -- the government was concerned with subscribership, not long distance usage, so it did not tax local service and instead taxed long distance, causing huge ineffiencies, so taking this argument could lead down a bad path.

Posted by: Greg Rosston at May 25, 2007 3:56 PM

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