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Comparing cell phones and cigarettes

by Daniel M. Rothschild on March 14, 2011

in Tax and Budget

One of the ways in which hard-up states are seeking to increase revenues is by increasing taxes on cell phones and other mobile communications devices, which when combined with federal taxes, can now total almost a quarter of a user’s monthly bills. (Indeed, only in three states is this total tax rate less than ten percent.)

Today an article on BNA suggests that on the federal level, lawmakers may have had enough. The Wireless Tax Fairness Act, which was introduced but never voted on in two previous Congresses, would prohibit  new “discriminatory” fees and taxes on cellular products. One of the bill’s sponsors, Rep. Zoe Lofgren of California, is quoted as saying “Some localities are taxing cell phones like sin taxes. I don’t think using a cell phone is like smoking, but that’s the tax rate.”

This stikes me as exactly right. A little background on basic public finance is in order. The purpose of taxes is to raise money for necessary governmental functions. To that end, economists frequently prescribe that rates be low and broad in order to minimize the impact on consumers’ behavior — so-called tax neutrality. This is because taxation should be about raising revenue, not changing behavior.

Some economists tweak this prescription through the Ramsey Rule, which holds (in a nutshell) that the more influenced by tax rates consumers are (demand elasticity) the less something should be taxed (and vice versa).

Sin taxes are the opposite; they’re about reducing a behavior that policy makers judge to be morally offensive (like many people view smoking).

Relatedly, Pigouvian taxes seek to bring the costs to society (the social cost) in line with the costs born by a buyer. (For instance, some people advocate higher alcohol taxes on the theory that drinkers impose costs on others, though this argument is fraught with difficulties.)

Cell phone taxes above regular sales taxes levied by states and localities do not fit any of the four rationales provided here. On the one hand, taxing them at over twenty percent of a user’s bill is hardly neutral. Nor does it likely fit the Ramsey Rule prescription; consumers respond to cell phone taxes by buying less of it or by avoiding taxes by pretending to move. (Just look around you at how consumer takeup and use of cell phones has changed as prices have fallen over the last decade.) Cell phones are not sinful or offensive. And there’s no serious case to be made that the social cost of cell phones exceeds the cost born by users. In short, by any principle of public finance, high cell phone taxes are a bad bad bad idea.

Cell phones are, most people’s revealed preferences show, a great thing. There’s simply no case under the principles of tax neutrality, the Ramsey Rule, sin taxes, or Pigouvian taxes to tax cell phones at these high rates. Policy makers would be well advised to cut rather than hike these rates going forward.

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