Lack of Taxes Costing States a Bundle

State and local governments will lose $13.3 billion in revenue this year because of the moratorium on the taxing of e-commerce purchases, according to a University of Tennessee study. These estimates are 41 percent higher than previous projections.

The study also predicts the problem will get worse. Projected annual revenue losses jump to $45.2 billion in 2006 and a staggering $54.8 billion by 2011, thanks in large part to skyrocketing B2B e-commerce activity.

The study was prepared by the Center for Business and Research at the University of Tennessee. Data was collected by Forrester Research, and the study was commissioned by the Institute for State Studies, a nonprofit public policy group.

The Internet sales tax (or lack thereof) is a sensitive issue among a couple of groups. The continued loss of revenue highlights fairness issues for so-called “Main Street” (offline) retailers. It also creates difficult choices for the 45 states and the District of Columbia that rely on sales tax revenue that can raise sales, income and/or property tax rates to compensate for the lost sales tax; cut services like education and public safety; or a combination of both.

Among the states the study expects to be hardest hit is Texas, which will lose $1.2 billion to e-commerce sales tax erosion in 2001. In Florida, the number is $932.2 million. Illinois will lose out on $532.9 million; Michigan will lose $502.9; Tennessee will lose $362.3 million; Maryland, $194.4 million. In the smallest states, the revenue erosion is also expected to be large. Wyoming will lose $26.1 million; Rhode Island, $36.8 million; North Dakota, $26.4 million; and the District of Columbia, $36.7 million.

“By 2011, the potential revenue loss in Texas alone will be $4.8 billion — that’s almost 10 percent of the state’s total expected tax collections,” said Donald Bruce, assistant professor at the University of Tennessee and the study’s co-author. “To make up for this revenue, Texas’s current statewide sales tax rate of 6.25 percent would have to rise to 7.86 percent.”

The study notes that, historically, states and localities have responded to sales tax erosion revenue by raising tax rates. In 1970, the median sales tax rate in the United States was 3.25 percent. This rose to 4.0 percent in 1980 and 5.0 percent in 1990. Fifteen states now have rates at or above 6.0 percent.

“We determined that, to make up for revenue losses due to e-commerce, states and local governments would have to raise their sales tax rates between 0.83 and 1.73 percentage points by 2011,” said William Fox, the study’s other co-author and University of Tennessee professor. “When other factors causing sales tax revenue to shrink are added in, the projected tax increases are even higher.”

In addition to erosion from remote sales, states and local governments are facing a loss of sales tax revenue from two other major trends: 1) a greater consumption of generally non-taxable services rather than taxable goods; and 2) a continual practice of state-legislated exemptions that are narrowing the tax base.

The online tax exemption was put into place to encourage e-commerce. While research has found that taxes often do not play a role in whether or not consumers purchase online, chances are consumers would notice when their total price at checkout goes up.

Earlier this year a Jupiter Consumer survey of U.S. online buyers that have abandoned a purchase by Jupiter Media Metrix found that only 21 percent abandoned one retailer over another to avoid paying sales tax for purchases under $50.

Further complicating the situation is the increasing dominance of offline retailers in the online world. Multichannel retailers are already required to collect tax in certain markets.

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