Taxation of Local Telephone Service

One of the many products that carry taxation from multiple different federal agencies, state governments, county governments, and city governments, is landline local telephone service. It is commonplace for consumers to subscribe to a 15-dollar monthly service plan and pay upwards of 30-dollars a month for this subscription plan after taxes and surcharges. Now that wide varieties of substitutes are available to consumers, from wireless to VoIP, it is easy to see how the desire of a product that is so heavily taxed could diminish. The economy reacts to taxation and price controls and we can look at how this has affected local landline telephone services.

Taxes and How They are Levied

Looking at the average phone bill, consumers will find various different line items that attribute taxes and surcharges to different agencies. These line items include: the federal excise tax (if billed separate from long distance), state tax, local tax (county and city), universal service charge (USF), 911, and the telecommunication relay service fee (Federal Communications Commission, 2008). All of these items listed are charges by governing agencies that are passed on to the customer and collected by the seller. In addition to these taxes and surcharges, the FCC also allows the local phone company to charge customer surcharges for additional items not included in the monthly subscription fee. Examples of these charges include access charges (sometimes called subscriber line charge) and local number portability (Federal Communications Commission, 2008). Because the customer becomes liable for the payment of these items, these taxes have a direct effect on supply and demand.

Effect on Supply, Demand, and Market Equilibrium

With the levy of these taxes and the wide availability of substitute products, buyers of telephone services demand less of this service. This results in a shift in the demand curve to the left (decreasing the quantity demanded). Buyers, as a result of the taxes, look at the total cost of local phone service, including taxes, and not at the actual market price (Mankiw, 2004). With a dramatic shift in demand, sellers try to offset the effect of the tax and encourage buyers demand by lowering the market price of telephone service. According to Mankiw (2004), a downward shift like this is lowered by the size of the taxes, without a shift in the supply curve.

Although the supply curve is not affected by a tax on the buyer, the downward demand shift creates a different market equilibrium price and demand, adjusted by the taxes. The new equilibrium of price and demand has buyers paying more for the service and the seller receives less for the product. May (2008), shares that the change in equilibrium price and quantity puts a chokehold on the competition in the telecommunications market. Now that the deregulation frees up the marketplace to competition, unchanged and regulatory tax laws hinder access to a larger market. May (2008), states "further loosening the regulatory grip would stimulate investment and innovation in high tech market places...a boost for the American economy." Since buyers are buying less and the provider is providing less, these taxes reduce the size of the local telephone market. So the effects of the taxes affect both the seller and the buyer, hence, both parties share the tax burden.

However, it is important to note that because there is a wide availability of substitutes available to the buyer, due to deregulation, internet competition (VoIP), and wireless services, the price elasticities of demand are elastic. This means that more of the tax burden would rest on the shoulders of the phone service providers than the buyer's. The phone service provider carries more of this burden because, as Mankiw (2004) states "that side of the market can respond less easily to the tax by changing the quantity bought or sold."

Hypothetical Price Ceiling and Market Implications

Imagine that because of the tax burden and consistent rising prices in the local telephone market, the government institutes a price ceiling on the price of local phone service. The price ceiling would be a legal maximum price that the local phone company could charge the customer. Let us say that initially the price ceiling was not binding because the equilibrium price and demand were below the legal maximum. Now imagine that as equilibrium prices and demand for similar telecommunication products and services offered by competitors settle above what many buyers are willing to pay. Many buyers, in the demand elastic environment, decide to substitute their current provider with the local phone service provider. In response to the increase in demand for local phone service, the local provider begins to raise prices. The rise in prices creates a new demand and price equilibrium that may settle above the legal maximum limit imposed by governing agencies. Although prices could be well above the allowed maximum, the local phone company is bound by the price ceiling. Because the provider is now bound by the price ceiling, if the quantity demanded by buyers exceeds the quantity supplied, the result is a shortage in service and the seller has no choice but to ration the service between the buyers (Mankiw, 2004).

Conclusion

The local telephone service provider is one example of how taxes placed on products and services affect the buying habits of the consumer and the seller's ability to sell. Taxes on goods cause demand to fall, effectively reducing the amount buyers are willing to purchase for the product or service. When new price and demand equilibriums are established, both the buyer and the seller share portions of the tax burden and the side of the market with less elasticity carries a bigger portion of that burden (Mankiw, 2004). For many different reasons price ceilings or floors can be established by governing authorities. As we have seen, when not bound to price controls, these impositions have little to no effect. Yet, when market equilibriums are bound by price ceilings (or floors) they directly affect the outcome of the market, causing shortages in supply (or surplus with price floors). Taxes are necessary in the economy to raise funds and, as we have seen, manipulate the outcome of a market. However, taxation and price controls have enormous effect on our economy and can be easily seen by looking at this example of a local phone company.

References:

Mankiw, N. G. (2004). Principles of economics (3rd ed.). Chicago: Thomson South-Western

Federal Communications Commission. (2008). Understanding Your Telephone Bill. Retrieved May 16, 2008, from http://www.fcc.gov/cgb/consumerfacts/understanding.html

May, R. J. ( 2008). Perspective: At FCC, Change Must Be The Mantra. In CNet News.Com. Retrieved May16, 2008, from http://www.news.com/At-FCC%2C-change-must-be-the-mantra/2010-1033_3-6231729.html?tag=item