Termination taxes

12 November 2015 | Tim Phillips

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Tim Phillips

Blog Author | Freelance writer


"Let those who will write the nation's laws, if I can write its textbooks," said Paul Samuelson, an economist who (not coincidentally) had just written a textbook. At this time of year, at least in the northern hemisphere, another cohort of students arrive at university to study ECON 101, which will focus on competitive markets and perfect competition.

"Let those who will write the nation's laws, if I can write its textbooks," said Paul Samuelson, an economist who (not coincidentally) had just written a textbook. At this time of year, at least in the northern hemisphere, another cohort of students arrive at university to study ECON 101, which will focus on competitive markets and perfect competition. 

Their lecturers will point out that perfect competition, in which the products aren’t differentiated and prices are given by market demand, in which customers know what they’re getting and are free to choose between suppliers, and in which there are many competitive suppliers who can enter and exit the market at any time, is an ideal that few markets approach. 

For 25 years, global telecoms has done probably more than any other established market to create this type of competitive environment. The spectacular long-term fall in prices of international calls that has resulted from deregulation and increased competition, leading to a sustained rise in demand, has gladdened the hearts of economics lecturers everywhere. 

See, they can tell their first year students: it can work. Most modern economics textbooks also have almost nothing good to say about government intervention in competitive markets. If students make it to about week six of ECON 101, they will probably draw a diagram showing the effect of a tariff: it results in revenue for the government, but also a deadweight loss to consumers and suppliers. In the telecoms market, taxes passed on to consumers as higher prices, mean that activity (telephone calls) that would have benefited both the carrier and the caller won’t take place. 

The benefit of the way government spends the tariff ought to outweigh the loss in consumer and producer surplus. This has been tested in many parts of the developing world over the last 10 years, as governments in the developing world - especially in sub-Saharan Africa - have raised termination taxes on inbound international calls. The 2015 GSMA report on Surtaxes on International Incoming Traffic (SIITs) concluded that these tariffs have raised international mobile call prices for consumers by 97% since 2010.

This isn’t necessarily bad in itself. You can make the policymaker’s argument that the people making the calls are likely to have a greater propensity to pay, and so these taxes have a small effect on both providers and callers: the total deadweight loss would be small. By definition, callers are outside the country, so we can argue that their welfare isn’t the government’s priority. Furthermore, in developing countries, taxes are notoriously hard to collect. 

So, compared to developed countries, tariffs are relatively attractive to policymakers because they’re hard to avoid. Add this together and this could represent an efficient way to redistribute wealth from the foreign wealthy (and predominantly foreign-owned carriers) to the domestic needy.

The OECD and GSMA’s research doesn’t support this argument. There is probably a large deadweight loss: the GSMA calculates that SIITs caused a loss of 1.2 billion minutes between 2010 and 2014. In 2014, the OECD published a detailed economic analysis of the effect of SIITs, suggesting that they create a large change in behaviour which ultimately reduces revenue: for a 1% rise in termination rates in Africa, it found international call volumes declined by 1.34%. 

The redistributive justification also seems flawed. The OECD, which focus on the effect on the people making the calls, concluded that “these practices first and foremost affect the diaspora”. Using separate figures of the growth of VoIP calling, it reasons that there is strong evidence that businesses and the middle classes simply displaced those minutes from mobile (taxed) networks to a different service - namely Skype. 

So the OECD’s analysis of traffic originating in the US and terminating in Africa shows a cost disproportionately falling on those who have no alternative but to use mobile calling, because they have no access to data networks. What can we tell first year economists? Perhaps that, if they want a career in telecoms regulation, it is going to be tougher than the introductory textbooks make out.