This article is from Cal-Tax Digest, published
by the California Taxpayers' Association.
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There is a revolution at hand - a quiet revolution that is not marked by battles and conflict, but by a reshaping of the way many Americans work and how we spend our time and money. It has been called the digital revolution, the electronic revolution, the information revolution, or the age of the Internet.

A growing number of government leaders say this revolution is going to cost them a lot of money. They fear the loss of sales taxes as more purchases are moved out of stores and onto the Internet. An initial economic analysis by the California Taxpayers' Association, however, shows that if electronic commerce adds even a tiny fraction to economic growth, other taxes will more than compensate for lost sales taxes.

In just a few short years of astounding growth, the Internet has reached a critical mass that is now attracting millions of consumers, and billions of their dollars, into a gigantic, ever-expanding virtual shopping mall. Over and over again, forecasters have been proven wrong as growth in electronic commerce exceeds their best estimates. The Christmas shopping season of 1998, for example, brought in about $3.2 billion in online shopping revenues. That was three times greater than the previous year, and the surprising growth caused forecasters to reevaluate and increase their projections for future growth.

Having said that this revolution is not marked by battles and conflict, there is one exception to note. The debate over lost sales taxes is turning out to be quite a political battle. This has long been an issue with mail-order catalog sales, because many of the companies involved are not required to collect sales taxes since they have no significant physical presence in the state where the consumer resides. Rapid growth in online shopping has taken a smoldering tax issue and turned it into boiling cauldron of controversy. Buying products from out-of-state companies that do not collect sales taxes has become much easier now, and tax collectors are concerned that more taxable sales will escape taxation.

This concern has led some state and local government officials to propose new taxes on electronic commerce, which in turn inspired Congress and the California Legislature to place a moratorium on these types of new taxes. These federal and state "Internet Tax Freedom" laws have drawn the ire of government advocates, and the conflict seems to be escalating.

The National Governors Association has estimated sales tax losses as high as $20 billion by the year 2002. Norm Alster, an advocate for taxing e-commerce, places the figure at $45 billion in 2003. These are very rough estimates. However, more detailed analyses, including studies by Dr. Austan Goolsbee at the University of Chicago and by the Pepperdine School of Public Policy (citing Jupiter Communications), have placed the loss in the range of $2 billion to $2.6 billion nationwide by 2002. The larger estimates appear to be grossly overstated, mostly because they include business-to-business commerce, which could inflate the figures by 800 percent. Business-to-business commerce is a huge and growing component of electronic commerce, but it does not generate significant sales tax losses, mostly because those sales are usually not retail sales. When they are retail sales, businesses are required to submit the sales tax (actually called a "use" tax) and are audited on these transactions to ensure their compliance.

Unfortunately, the policy debate thus far has focused almost exclusively on sales tax and ignored some very important facts and a whole universe of other taxes. Sales taxes account for about 25 percent of state and local tax revenues. Why isn't anyone talking about the other 75 percent? All of this economic activity surrounding the phenomenal growth of electronic commerce is generating tax revenues. Personal and corporate income taxes are being collected on billions of dollars in salaries of e-commerce employees and earnings of business owners. Property tax is being collected on expensive, high-tech equipment used to power the networks, run the web servers, and equip the offices of these companies. There are also business license taxes, utility taxes, excise taxes, and telecommunications taxes paid by e-commerce proprietors and those who provide access to the web.

Stephen Kroes is vice president and research director for the California Taxpayers' Association.

 
And let's not forget all the additional telephone taxes paid by the millions of web "surfers" who have installed second phone lines or expensive, high-speed lines to facilitate their online access. In fact, the digital revolution has spawned so many requests for additional telephone lines that many of us are in new area codes, and phone calls that used to be local are now long distance. The increased volume of long distance calls leads directly to increased utility user taxes in most California cities.

Although we cannot yet show how much these taxes are reaping from e-commerce activities, an analysis of economic statistics and historic tax collections reveals that it is quite likely that other tax revenues exceed the amount of sales taxes presumed to be lost to e-commerce.

The broadest, most trusted measure of the output of the national economy is Gross Domestic Product (GDP). It is not difficult to estimate how much tax revenue is generated by a given increase in GDP. A dollar of GDP produces about 9.5 cents in tax revenue for state and local governments. This ratio has been fairly constant throughout the 1990s. If sales taxes are excluded, each dollar of GDP produces about 7.15 cents in state and local tax revenues.

Using this knowledge, we calculate that if e-commerce adds a mere 0.36 percent to GDP by the year 2002, over $2.6 billion in state and local revenues are produced from income taxes, property taxes, and all the other non-sales taxes mentioned above. So, if e-commerce contributes even a tiny fraction - about a third of one percent - to the U.S. economy, it is a revenue winner for states and localities.

The table below summarizes these findings along with similar estimates for California. The California sales tax loss estimate is derived from California-specific estimates of online shopping volume calculated by Jupiter Communications and cited in the Pepperdine report. California's increase in Gross State Product (GSP) that would be needed to offset sales tax losses is slightly higher than the national figure because sales taxes are higher in California than most states and because California has a large share of online shoppers.

Is it realistic to think that electronic commerce might generate an additional 0.36 percent of GDP to the national economy? It certainly is not a large number, and it seems likely that e-commerce does generate economic growth. This growth can come from new jobs and profits generated by new businesses, increased business productivity, lower business and consumer transaction costs, and increased consumption of high-tech equipment and consumer items.

E-commerce is producing jobs. A recent study by Cisco Systems and the University of Texas concludes that the U.S. "Internet economy" is responsible for 1.2 million jobs and $301 billion in revenue. Of those totals, 482,000 jobs and $102 billion in revenue are traceable to the actual sale and purchase of goods and services on the Internet. The rest of the jobs and revenues come from related activities, such as building the technology infrastructure that supports the Internet.

Recent data also show increases in U.S. productivity, especially after 1995. Some of that may be related to the expansion of e-commerce. For example, Richard Hall, a spokesman for Intel Corporation, states that over half of his company's sales are now booked, billed, and managed on the Internet. Two years ago, that figure was zero. Companies are making these changes for simple reasons - they reduce costs, improve management of core business functions, and increase productivity. Increasing business productivity and lowering transaction costs lead to higher profits and more efficient use of resources. These changes generate profits, and profits generate tax revenues.

The economy also grows when businesses and consumers purchase new equipment, such as computers, switches, routers, modems, and all the other equipment needed to use or serve the Internet. If the ease of online shopping and the need to serve online customers have prompted individuals and businesses to purchase more goods and services than they otherwise would have, GDP is increased. Indeed, personal consumption expenditures and business investment in durable goods have shown solid growth in recent years.

All of these factors confirm the idea that economic output is likely increasing because of growth in electronic commerce. As economic output increases, state and local governments reap greater tax revenues. These tax revenues can more than compensate for lost sales taxes, and it's time government officials start looking at the big picture and begin talking about e-commerce in a more balanced, rational way.

What taxpayers need and expect from elected representatives is not a new wave of intrusive taxes, especially taxes that are justified by dubious statistics. Policy-makers should be fostering the growth of this new medium or at least allowing it to pursue its natural evolution without punitive taxation.

The Internet is revolutionizing American culture and America's economy. Let's not stand in the way of progress.