Subj: Economic Impact on States: Perspectives of IPI: Center for Technology Freedom From: Bartlett Cleland Institute for Policy Innovation To: Internet Caucus Advisory Committee Would States Lose Revenue? When consumers choose to buy a product or service online rather than in a retail outlet, in most cases they avoid any applicable sales taxes, which means a state loses that revenue. A retailer selling a $1,000 computer might have to charge a purchaser, say, $80 in sales tax, while that same customer might be able to buy the computer tax free over the Internet—thus saving the customer $80, less shipping costs, and costing the state $80 in revenue. Tax proponents contend that over time and as e-commerce grows, states will lose significant amounts of revenue, threatening essential services that the public has come to want and expect. For example: * Economist Henry J. Aaron of the Brookings Institution has written, " Whatever its strengths, however, e-commerce hasn't eliminated the need for schools, fire departments, police forces, parks, libraries, health care and other government services and for the revenue to maintain them." The implication, of course, is that without an Internet sales tax, these services would be threatened. * Joseph Brooks, a councilman for the city of Richmond, Virginia, speaking on behalf of the National League of Cities, National Association of Counties, U.S. Conference of Mayors, National Conference of State Legislators, National Governors' Association, Council of State Governments and International City/Council Management Association, has said: "We believe the lost revenue from tax-free online shopping will be significant—between $9 and $11 billion by 2004. If our sales taxes shrink dramatically or even disappear because of tax-free online shopping, we will be forced to raise taxes in other areas to provide essential public services like police and fire protection and public education." * "None of us wants to pay taxes," Dallas Mayor Ron Kirk, a member of the Advisory Commission, has said with regard to taxing the Internet, "but you certainly don't want the phone to go unanswered when you have a fire, or when you have a need for police." The assumption behind this argument is that if online sales increase, state revenues will decrease. That is not necessarily true. Both retail sales and state sales tax receipts have continued to grow during the decade of the 1990s, even with the growth of Internet sales. How can sales tax revenues continue to grow while more people buy online? Several reasons. 1. First, although people like to point to aggregate online sales, many of these purchases would not be taxed if bought in-state. For example, online pharmaceutical sales have been growing rapidly, but prescription drugs are not generally subject to the sales tax. In addition, many people purchase such items as airline tickets online, which are not typically subject to state sales taxes. 2. States have various ways of collecting at least some of the sales and use taxes for out-of-state mail order and online purchases. California is collecting taxes on out-of-state cigarette purchases. And Texas collected $1 billion in use taxes in the last budget year, according to the state comptroller's office. 3. There is an assumption that there is a direct trade-off between an online purchase and a lost retail sale. However, online consumers are just as subject to impulse buying as those shopping retail—perhaps moreso in certain areas such as technology products. They might never have bought the product if they had to get in a car and go to the store. In other words, a retail outlet didn't necessarily lose the sale because the consumer had no intention of going to a retail store to buy it. 4. Finally, online sales have a "multiplier effect" that spurs sales both online and in retail stores, and thus spurs economic growth. For example, online sales are helping to keep inflation down which generates more economic activity. Economists Ethan S. Harris and Joseph T. Abate of Lehman Brothers found that Internet prices average 13 percent lower than retail stores even with the shipping costs. In addition: ?????Prescription drugs, which would not be subject to sales taxes, averaged 28 percent cheaper online; ?????Alcohol and tobacco are 28 percent cheaper, but states have ways to collect those taxes; ?????The savings for electronic products was only 4 percent; ?????While toys and hardware actually cost more online than in retail stores. Indeed, people expect to find lower prices online. According to KPMG, 60 percent of online shoppers expect to pay less when they buy something online than if they buy it in a retail store. Only 37 percent expect to pay about the same. The price competition created by Internet sales is keeping prices down for both retail and online sales, and that spurs economic growth. Of course, this type of competition might be short-lived, and there is some evidence that online and retail sales prices might be converging. But without that competition, prices would be higher and sales would be lower—which would cost the states money. Sales Taxes Assessing the economic impact of taxing Internet sales is a daunting task because there is very little to compare it to and almost no previous scholarly analysis. Fortunately, Austan Goolsbee of the University of Chicago's Graduate School of Business and the National Bureau of Economic Research has managed to make an assessment of the economic impact of Internet taxes. Goolsbee's first task was to determine the consumers' tax sensitivity (i.e., how willing they are to substitute an item with little or no tax for one with a higher tax). This type of work has already been done in border regions, where people have the opportunity to easily cross a border, say, into the next state, in order to pay a lower sales tax. Research has shown that people living in border areas are highly sensitive to taxes, according to Goolsbee. The next step was to look at online sales in high-tax areas. "Controlling for individual characteristics, people who live in high sales tax locations are significantly more likely to buy over the Internet . . . . The estimated tax price elasticities of Internet commerce are large and resemble those found in previous studies of taxes in geographical border areas. The magnitudes suggest that enforcing existing sales taxes on Internet purchases could reduce the number of online buyers by as much as 24 percent." Thus, Goolsbee thinks effectively imposing the current state sales and use taxes on Internet purchases could slow e-commerce by a quarter. Based on the projection that business-to-consumer sales, left unhindered, are predicted to reach about $108 billion by 2003, that would mean a reduction of $27 billion in the economy. And remember, people may not necessarily go to a brick-and-mortar store to buy the product if they can't get a good price on the Internet. Some of that $27 billion will be lost economic growth.