The IRS Hates Air Travelers

The airline industry just got emboldened by the IRS last week. The IRS has decided that checked baggage fees are not taxable under federal air travel excise tax because of an exclusion that says fees for baggage transportation are not taxable. Of course, the IRS neglected to state, or just forgot, that prior to airlines charging checked baggage fees, the cost of baggage was incorporated in the fare, which was subject to excise tax.

This literal interpretation of the IRS Code could embolden the airlines to further unbundle the components of their airfare and charge for them separately, knowing they will not need to share the revenue with the government. Air travelers will be much less sensitive paying a rounded fee, such as $25, versus having to pay $25 plus the excise tax.

With the airlines not needing to worry about excise tax, they can unbundle other parts of the fare that were once subject to the excise tax. Eventually, airlines can charge a nominal fare, such as $10, and have separate specific charges for everything else, such as fuel, a seat, baggage, drinks, etc. Only the $10 fare will be subject to the excise tax, and the airline can keep all the other revenue for itself. For those who think this is unlikely, look at Ryanair, the deeply-discounted airline in Ireland. They do exactly this.

Normally I hate taxes and think companies should do everything in their power to avoid them. However, the airline industry is different. The airline industry relies on many different layers of government, local governments that apply fees on tickets to pay for airport renovations and the federal government for security (not the TSA, but other security), air traffic control and other administrative assistance. Most other industries can repay this government assistance through other means, like corporate taxes on profits or personal taxes through dividends, but the airline industry is almost always unprofitable and certainly does not give dividends to shareholders. Excise taxes are almost the only way the airline industry pays for the infrastructure that it uses.

Unbundling could undo the airline industry's only contribution to the government that subsidizes it so much. The IRS should have imposed the excise tax on baggage fees, telling the industry that it should rightly be considered part of the fare. Even if the IRS Code excludes the cost of transporting baggage, that was intended to apply solely to bags flying independent of passengers. Applying the rule literally will hurt the traveling public.