Many state and local officials believe the sky is about to start falling because retail sales taxes are routinely disregarded in online (Internet) transactions. The National Association of Counties and U.S. Conference of Mayors have even filed a lawsuit to prevent meetings of the Advisory Commission on Electronic Commerce, which was created by Congress to recommend future Internet tax policies.
The National Governors’ Association recently stated that by 2002, states will lose $20 billion in revenue from online transactions.
These dire estimates seriously exaggerate the effect of electronic commerce on state coffers because they do not account for the following facts:
The vast majority of online sales are from one business to another, which are not subject to sales taxes anyway. No more than five percent of online transactions are retail sales to consumers, according to the U.S. Department of Commerce.1
A significant number of online retail purchases, such as travel and financial services, are services not subject to state sales tax in any form, electronic or otherwise.
Many other online transactions are for goods that often require the seller to have a presence in the buyer’s state in order to collect the sales tax, so states already have authority to tax these sales. Notable items include automobile and grocery purchases.
Some Internet transactions, such as many computer purchases, substitute for mail-order purchases where the buyer and seller are located in different states. Even if there were no Internet, a state sales tax still would not have been paid on many of these transactions, since a state cannot collect sales taxes from businesses that do not have operations in that particular state.
Researchers at the University of Chicago and Harvard University recently calculated the impact of Internet transactions on sales tax revenue, adjusting for the factors listed above. They found that online transactions reduce state and local revenues by only $430 million annually – less than one-quarter of one percent of total sales tax revenues. Industry watchers expect online sales to grow by 70 percent per year over the next few years, but even then, the revenue lost will represent less than two percent of sales tax revenue in 2003.2
1Calculated from U.S. Department of Commerce, The Emerging Digital Economy II (June 1999), p. 5.
2Austan Goolsbee and Jonathan Zittrain, “Evaluating the Costs and Benefits of Taxing Internet Commerce” (Manuscript, May 20, 1999).