State and local government finances are being undone by rapid changes
in global commerce and technology, particularly the rise of the Internet.
The key revenue base of state and local governments--sales taxes--is being
undermined through the rise of untaxed commerce on the Information
The Emerging Crisis:
- According to the U.S. Advisory Commission on Intergovernmental
Relations, an estimated $3.3 billion in state and local sales taxes are
now lost each year due to untaxed mail order sales from out-of-state
- While not a large factor in commerce yet--maybe $200 million in direct
Internet sales in 1994 by one estimate--commerce listings on the Web are
exploding exponentially. The number of "World Wide Web" pages used to
present businesses and products is growing at about 12% a month.
- Intuit, Inc. and MasterCard International are among companies
announcing that they will support new protocols for securing on-line
credit card, debit card, charge card, and micro-financial transactions.
With this new technology, the floodgates of Int ernet commerce are about
- Because of Proposition 13, state and local governments in California,
including, ironically, those of Silicon Valley where the computer
technologies fueling Internet commerce were created, are extremely
dependent on sales taxes to fund their budgets, so any increase in untaxed
interstate sales will be magnified there.
Roots of the Crisis:
- Beginning in the early 1980s, the federal government began to cut
funding to the states, forcing states and local governments to pay for
more and more services out of local budgets with sales taxes often the
revenue of choice. Th ese two trends-more out-of-state sales and a
greater dependence by local governments on sales taxes-are now on a
- The Supreme Court in its 1967 National Bell Hess, decision and
reaffirmed in its 1992 Quill Corp. v. North Dakota decision, declared that
interstate mail-order firms were exempt from state sales taxes.
- The technologies of direct marketing, such as the use of toll-free
numbers, computers, and faxes have allowed companies to dispense with the
need for sales personnel, inventory, or showrooms within states. With
Internet Web pages increasingly replacing catalogs mailed to people's
homes, it is clear that the physical connection between mail order
retailers and states trying to tax them will recede even farther.
- The irony in the movement towards "local control" and "decentralizing
government" is that the increased dependence on local taxes and revenue is
pushing governments towards either burdensome taxes on business or more
intrusive government on the indivi dual in order to collect those
out-of-state sales taxes.
The Burdens on Local Government from the Sales Tax:
- Local government competition for retail
sales revenues has created a ludicrous distortion of economic development
patterns as cities have had to desperately bid for successive waves of
retail evolutio n. Direct marketing through phone, cable or the Internet
is pushing this economic cannibalism to a new level.
- Governments are being pressured to leave Internet sales untaxed.
California passed AB 72 in 1994 which created a sales tax exemption for
out-of-state businesses that advertise on California-based on-line
services, primarily so Apple Computer's E-wor ld would not lose out to
services based in other states.
- Another good reason to begin eliminating the sales tax is simple:
sales taxes aren't fair and states that depend most on sales taxes, such
as Texas and Washington, have the highest tax rates in the country for the
To respond to the challenges of rising electronic
commerce, the Center for Community Economic Research makes three broad policy recommendations:
The threatened loss of local sales taxes due to mail-order and on-line
commerce should be treated as an opportunity to look more closely at the
burdens we put on local and state governments. We should question whether
such burdens make sense in a world where multinational corporations often
outpower whole states in total assets and can pit such local governments
against each other in competition for jobs and l ocal revenue.
- Centralize revenue collection to the state and national levels.
- Scale back and even eliminate sales taxes as a revenue source
- Legally prohibit "subsidy abuse" by local governments in competition
for business location
Center for Community Economic Research
c/o 2521 Channing Wy. Berkeley,
CA 94704 (510) 643-8293 * firstname.lastname@example.org