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The Telephone Excise Tax: An Economic Analysis

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Abstract:

The federal telephone excise tax generated $5.9 billion in revenue in fiscal year (FY) 2005. Since at least 2004, however, many taxpayers have challenged the legality of the telephone excise tax as it applies to toll (long distance) telephone services. The courts issued several rulings supporting the taxpayers' position that long distance toll services are not taxable and have ordered refunds. On May 25, 2006, the U.S. Treasury Department conceded defeat and announced that the Department of Justice "...will no longer pursue litigation and the Internal Revenue Service (IRS) will issue refunds of tax on long-distance service for the past three years." This decision will likely initiate further congressional review of the remaining tax on local telephone services. Options include repealing or significantly modifying the structure of the telephone excise tax. Complete repeal of the tax has been estimated by the Congressional Budget Office (CBO) to cost $67.0 billion over the FY2006 to FY2015 budget window. The Joint Committee on Taxation estimated that repeal of the remaining excise tax on local telephone services would cost approximately $7 billion over the 2007 to 2016 budget window.

In the 109th Congress, S. 1321 and its companion, H.R. 1898, would repeal the telephone excise tax entirely. On June 28, 2006, S. 1321 was approved by the Senate Finance Committee. S. 758 would prohibit the extension of the telephone excise tax to Internet access services. In addition to a review of current legislation, this report provides a brief history of the telephone excise tax, a discussion of the current legal issues, and an economic analysis of the telephone excise tax.

The telephone excise tax is relatively simple for the federal government to administer as third parties collect the tax and monitor compliance. The tax generates roughly $6 billion annually for the federal government. The tax, however, does not treat similarly situated taxpayers equally and is regressive. In addition, economic theory suggests the tax is inefficient, reducing overall economic welfare.

For a history of the telephone excise tax, see CRS Report RL30553, The Federal Excise Tax on Telephone Service: A History. This report will be updated as legislative events warrant.