From the Wall Street Journal  October 20, 1993  Page 14
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A Detour on the Information Superhighway

by Brian Miller


Bell Atlantic's plan to acquire Tele-Communications Inc. in a stock
transaction valued at more than $16  billion helps to make the case
for naming telecommunications as the fastest growing and most important
strategic industry in America.  New products and services are constantly
being invented.  But misguided state tax polices around the country,
promoted by authorities who view the information superhighway as
simply another source of revenue, threaten to undermine the growth
of the many small-fry businesses that provide these services.
My wife's and my experience with our on-line information-service
company in Massachusetts is one example.

People subscribe to our service to get access to electronic mail and
computer bulletin boards, to download public-domain programs from our
library, and to play computer games.  They dial in over ordinary phone
lines, using a personal computer and a modem.

We don't charge our customers sales tax because our state law says we
don't have to.  There is a tax on telecommunications services, which
the law narrowly defines as services that provide for the transmission
of messages through microwave, wire or fiber-optic cable.  But the law
specifically exempts the sale or use or use of information.  So in a
transfer of information where a fee is paid, the transmission of the
fee is taxable, but the information itself isn't.  This means our
customers pay state sales tax on their phone bills when they dial in
to us, but not on the services we sell them.

To our amazement, Massachusetts decided after a recent audit that we
potentially owe back taxes on all of our subscriber billings.  As it
interprets the law, whenever one of our subscribers leaves an electronic
note on a bulletin board, this constitutes "the transmission of a
message" and is subject to a 5% state sales tax.  The assessment
could amount to more than $150,000 and would put us out of business.

Other technology-based businesses accessing information via telephone
modem are also subject to similarly tenuous interpretations of the
state tax law to justify what amounts to a de facto modem tax.
Is the state quietly trying to set precedents to allow it to expand
this sales tax into information services?  Some states, including
New York, Florida and Pennsylvania, have either already instituted
similar taxes or are considering them - demonstrating a woeful lack
of understanding of the effects of sales taxes on businesses that
sell on-line or other information services.  For the tax wonks
around the country, we'd like to explain what a modem tax would do
to our business.

On-line information-service fees are based on how long the user is
logged on and how much information is transferred.  Because we use
modems that are almost twice as fast as those of other on-line
services, our subscribers have much shorter connect times (and lower
connect costs) than they would for the same transaction with a
competitor.  When this is factored into the total bill, it gives us
enough of a cost advantage in our particular niche to allow us to
compete with the large national on-line services.

Raising our prices 5% to pay for a state sales tax would cut
significantly into our cost advantage and we would lose customers.
At a time when the large national services, with economies of scale
that we can't match, are lowering their prices to compete with
each other, we can't afford to raise ours.

Alternatively, we could keep prices the same and pay the sales tax
ourselves.  But profit margins for small, on-line services like ours
are typically less than 10%.  So absorbing the tax would be the same
as turning over half our net profits just to stay competitive.

There is a third option, but it would have us move our business,
its current and future jobs, to neighboring New Hampshire, where
we wouldn't have this problem - for now.

This demonstrates the basic mistake many government tax analysts
make.  To them, every new and growing industry is a stable source
of cash from which they can extract tax revenues without disturbing
the market that industry serves.

But it doesn't work that way.  The economy of this country is based
on free markets.  And free markets are ruthlessly efficient as
consumers constantly maximize their own benefit by finding the best
products at the best prices.  So even what appears to be a small tax
increase on a particular industry often has the effect of distorting
that industry, eliminating jobs and businesses in the process, and
reducing the tax revenues the government used to justify the tax
in the first place.

The telecommunications industry is projected to grow from $700
billion world-wide today to $3 trillion in the next decade.  But if
states are to succeed at tapping into the bonanza of jobs and profits
the telecommunications industry is about to deliver, lawmakers need
to understand that economic growth doesn't happen in an environment
of punitive tax rates and an adversarial tax collection system.

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              Mr. Miller and his wife, Tess, own and
              operate Channel 1 in Cambridge, Mass.


                       (Not in the article)
              Channel 1(R)  617-354-3230  14.4 V.32bis