Internet Sales Tax: a Survey of Actual Lost Revenues to One State

The advent of the World-Wide Web in 1992 eventually led to the advent of electronic commerce. eCommerce has led to the decline in sales tax revenues for various collection agencies across the U.S. The federal government has issued, and renewed, a moratorium on Internet taxes, and thus state and local governments are restricted from collecting sales tax from Internet sales. Coupled with a demise of the U.S. economy post 9-11, most states have suffered budget problems, and some a budget crisis. In response to the declining state coffers, many states are seeking to tax Internet sales. But just how much revenue is actually lost to Internet sales? This research attempts to answer the question from both the literature and a survey of citizens from one state. GROWTH OF E-COMMERCE ACTIVITIES These problems are associated with the exponential growth of the Internet and electronic commerce (eCommerce). Between 2002 and 2005, the number of consumers using online account management will more than double, reaching 45 percent of the U.S. adult population. On the retail sales side (B2C), eCommerce sales grew 92% from 1999 to 2000, with a total of $29 billion. On the wholesale side (B2B), eCommerce transactions increased 17% from 1999 to 2000, with a total of $213 billion. In the service sector, sales increased 48% from 1999 to 2000, with a total of $37 billion. Retail sales for 4Q 2001 were up 13% over 2000 at $10 billion. It is estimated that sales for the year of 2001 were $32.6 billion, an increase of 19% from 2001. According to the U.S. Census Bureau, online sales were approximately $34B in retail sales (B2C). Although the level of growth has slowed somewhat, the overall growth of e-commerce sales is still increasing. FEDERAL MORATORIUM ON INTERNET SALES TAX On May 10, 2000, the House voted 352-75 to extend a moratorium on Internet taxes for five years (H.R. 3709). It will expire October 1, 2006. The House bill is an extension of the 1998 Internet Tax Freedom Act which prohibited taxing access to ISPs, such as AOL, and prevented certain state and local taxes until October 1, 2001. [OMB Watch 2000] Since then, 100 members of Congress have signed on to make permanent the five-year moratorium against levying taxes on the Internet that are not levied elsewhere. States have put together the Streamlined Sales Tax Project (SSTP) to set guidelines for online sales tax. The first step will be to agree on definitions of items to be taxed. More than 27 states plan to introduce legislation to adopt the new rules as state law, according to the SSTP. Seven states actually have the right to tax Internet access: New Mexico, North Dakota, South Dakota, Ohio, Tennessee, Texas, and Wisconsin. Those states levied taxes on Internet access before Congress passed the first moratorium in 1998. The states have, however, largely respected the moratorium and refrained from imposing the access taxes. LOST REVENUES TO STATE GOVERNMENT AND AGENCIES Traditionally, sales tax has been collected by the retailer at the time of sale and then remitted to the applicable state and agencies. This collection is based on the principle of nexus. But making sales in a state does not necessarily mean nexus has been established. For example, nexus will not be applied to mail-order catalog sales for sales tax purposes. To compensate for lost sales tax for these types of nonnexus sales, states collect use tax. While the burden for collection of sales tax is upon the merchant, the burden for use tax is upon the buyer. Because it is based on citizens voluntarily paying it, use tax is probably not paid very often [County Commissioner 2002]. However, the state of Alabama reported use tax on 2002 income tax returns of $219,276, up from $203,344 the year before [ADOR 2003]. Thus the question becomes one of nexus for eCommerce vendors. Should they be considered the same as mail-order catalogs or a retail store? Two court cases are likely to matter in this decision. The first Supreme Court case found that mail-order sellers would not be required to collect sales tax. But in the more recent second case, the Court reversed its position and found that the mail-order corporation had an “economic presence” in the state because it directed activities at the residents therein. However, the Court maintained its position of not requiring the seller to collect sales tax based on the commerce clause argument about lack of physical presence. [Curator 2002] Merchants often must complete an avalanche of forms to comply with sales tax processes. For the small business in particular, this burden has been a real problem, primarily because the forms and process are complicated. For example, five states allow cities and counties to collect their own sales tax, and merchants must calculate a sales tax form each month for each city and county where it has sales transactions, each one possibly with a different format. [Doyle 2001] Another problem involves the ability of the collecting agency to oversee out-of-state entities that sell inside the jurisdiction of the agency. For example, in five states, cities and counties collect their own sales taxes. But can a city really make sure all out-of-state entities that sell in the city are paying appropriate sales tax? If that is expanded to the Internet, how will the city ensure adequate compliance? But the greatest problem is the declining revenues from sales tax for state governments and state agencies. It is widespread across the U. S., and causing many states to go through pro-ration during the fiscal year, over the last few years. In California, for example, the budget deficit reached $35B, and state leaders believe the way to fix the problem is to tax Internet sales. And a 2001 study by the University of Tennessee suggested that losses from uncollected levies on Internet sales would jump to $45B by 2006, and $55B by 2011. [Morrison 2003] Texas has similar complaints, and Pennsylvania believes its losses are somewhere between $100M and $1B [Philly 2003]. But how much of the decline is responsible by purchases made over the Internet tax-free, and how much is the general demise of the U. S. economy? According to the U.S. Census Bureau, catalog and online sales together totaled $109B in 2001 nationally; at a ratio of 3:1 catalog sales. The resulting loss depends on the individual state and item sales tax rates, but the figure could be $1B nationally. But some multi-channel retailers (e.g., Toys “R” Us, Wal-Mart, Target) began collecting sales tax on online purchases early in 2003. The transition has come without much fanfare or fallout. In addition, sales tax revenues in the U.S. rose 26% in the first two months of 2003 as compared to 2002, and reached a total of $14B. [Regan 2003] This research attempts to answer the question as to how much sales tax revenue is being lost to sales over the Internet in the state of Alabama. The authors decided to survey citizens of Alabama and ask them how much they are spending over the Internet, and how much of those sales are being reported as use tax to the state. The research will attempt to estimate the annual loss of sales tax revenue for 2001.