PROP 13 MEETS THE INTERNET:
   HOW STATE AND LOCAL GOVERNMENT FINANCES ARE
BECOMING ROAD KILL ON THE INFORMATION SUPERHIGHWAY




A REPORT BY:

Nathan Newman
Center for Community Economic Research
University of California, Berkeley


August 1995




TABLE OF CONTENTS

Cover Page

Executive Summary

"A House of Cards"

How Real is the Danger of the Internet to Local Taxes?

How  Much Money Is At Stake?

Total Tax Lost by States to Mail Order (Table 1)

California Counties Most Vulnerable To Sales Tax Losses, 1993
(TABLE 2)

California Cities Most Vulnerable to Sales Tax
Losses, 1993 (Table 3)

Why States Can't Collect Out-Of-State Taxes: The Quill Decision

Business and Consumer Burdens of Mail Order Sales Taxes

Sales Taxes and Economic Development

Sales Taxes and the Effects on the Poor

Policy Recommendations:

Conclusion:

Footnotes


COVER PAGE

About the Center for Community Economic Research:  The
Center for Community Economic Research (CCER) is a project of UC-
Berkeley's Institute of Industrial Relations and Institute for
the Study of Social Change.  CCER acts as a bridge between
researchers and community groups throughout the Bay Area and
California. CCER strives to give community groups the kind of
university support they desperately need in their fight to
empower people around economic issues and to enhance our
democracy.

     Projects have included a February 1994 conference on
"Community-Based Research" cosponsored with the SF State's Public
Research Institute, research support for a variety of community
organizations, and assistance to community groups in getting
access to Internet resources and promoting community information
on-line.   The CCER-sponsored on-line server was named one of
twenty-nine worldwide "Highlights of the Internet" by PC
COMPUTING in its September 1994 issue.  CCER is doing
extensive support to the Association of Bay Area Governments in
developing a model for electronic communication by cities and
agencies with the public.   In June 1995, CCER established an
interactive "National Budget Simulator" on the World Wide Web to
enhance economic literacy around the federal budget.


Contact Information:

Center for Community Economic Research
2521 Channing Wy.
Berkeley, CA 94720
(510) 643-8293
ccer@violet.berkeley.edu
http://garnet.berkeley.edu:3333/





EXECUTIVE SUMMARY

     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 Superhighway.

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 firms.

*  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 Internet commerce are about to open.

* 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.  These two
trends_more out-of-state sales and a greater dependence by local
governments on sales taxes_are now on a collision course.

*  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 individual 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
evolution. 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-world 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 poor.

POLICY RECOMMENDATIONS:    To respond to the challenges of rising
electronic commerce, the Center for Community Economic Research
makes three broad policy recommendations:

* 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

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 local revenue.



"A HOUSE OF CARDS"

     In 1995, the United States is debating the shift of many
spending responsibilities from the federal government to state
and local authorities.  While much of the current debate focuses
on the total amount of money spent, a graver concern is being
overlooked: whether the revenue base of state and local
governments is stable enough  to deal with 21st century
responsibilities.

     This report argues that their revenue base is not stable;
state and local government finances are being undone by rapid
changes in global commerce and information technologies,
particularly the rise of the Internet. These changes are
undermining state and local governments'  key revenue base: sales
taxes.  Even as many states and local areas hope for increased
revenue due to high technology-based growth, the rise of  untaxed
commerce on the Information Superhighway may be another body blow
to local government finances.

     In the last few decades, interstate mail order sales have
expanded, with most of the commerce going untaxed because of
Supreme Court decisions barring such taxes based on the rules of
interstate commerce.  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 mail
order sales.1

     And this lost revenue is based on current technology.  With
the growth of the Internet and on-line sales, consumer access to
a nationwide and worldwide marketplace will expand exponentially.
At a push of a button, consumers will have access to the lowest-
priced goods nationwide and, with the added bonus of avoiding
sales taxes, interstate sales may explode over the Internet
leaving state and local government finances in tatters.

     Ironically, California, at the heart of the new Internet
technology, is likely to feel the most severe effects of this
change.  Because of Proposition 13, state and local governments
in California are extremely dependent on sales taxes to fund
their budgets, so any increase in untaxed interstate sales will
be magnified here.  Wally Dean, mayor of Cupertino, CA, sums up
the shock his government colleagues will feel as Internet sales
take off in the next few years, undermining their traditional tax
and economic development goals:

"The thing that scares us is that cities are run on local
sales tax; if stuff is sold on the Internet, there's no sales
tax.  It's a house of cards for government finances.  This could
be the Achilles heel for state and local government.  And it's an
invisible problem.  The average retailer has no clue what a
computer is... it's not in their vocabulary.  It's changing that
where you once had a manufacturer selling to a wholesaler to a
retailer.  If this gets hot, you'll have a manufacturer going on
the Internet and selling directly to the mass market--bypassing
the sales tax.  We once built city government on local
manufacturers and sales--you didn't think globally.  This will
mess with a lot of people's heads."2


HOW REAL IS THE DANGER OF THE INTERNET TO LOCAL TAXES?

     Corporate America is turning to the Internet as a day-to-day
tool for working with business associates and for marketing to
customers.  The explosion of Internet use by corporations is
almost dizzying. "Companies are registering on the Internet at
outrageously exponential rates, with about 120 requests per day
by commercial entities, ranging from Fortune 500 companies on
down," says Anthony Rutkowski, vice-president of the Internet
Society and director of technology assessment for Sprint
International. "It is doubling in size every nine months."3

     While not a large factor in commerce yet--with maybe $200
million in direct Internet sales in 1994 by one estimate4--
commerce listings on the Web are exploding exponentially.  The
number of Web pages  advertising businesses and products is
growing at about 12 percent a month.5  There are already more
than 500 Web sites dedicated just to restaurants around the
United States and Canada--and the number is growing by the day.
Restaurants from San Francisco to Boston are using the
graphically based Web to reach customers in ways that
conventional advertising can not. "We're real pleased with the
response," says Bill Jones, CFO at the Virginia Diner, which
first offered a Web page last August. The restaurant, which has
300 seats but does 75 percent of its business by mail, has
received orders for its products from France, Germany and Japan.6
Other businesses are adding on-line advertising sites to
supplement their regular mail order solicitations.

     While few direct sales are being made over the Internet, an
on-line presence does make it easier for companies to expand mail
order operations and makes it easier for customers to find
products to order, even if the sales are today done mostly over
the telephone.  Mark Masotto of CommerceNet, a consortium of
businesses exploring use of the Internet, observes,  "Clearly,
you'll see more and more stories emerging of how putting
information on the Internet is reducing the number of phone calls
and number of brochures distributed.  There are intangibles of
being able to provide information twenty-four hours a day and not
have to have people on the phone all the time to service an
international market. The medium provides much more possibility
to do interactive support--you can read and search information,
immediately pull up the information you are interested in rather
than looking through a whole catalog of information.  It makes
the person reading the information more effective in finding
information."7

     Up until recently, the largest barrier to on-line commerce
was the lack of security  on Internet connections such as the
World Wide Web, so fears that hackers could intercept messages
and steal passwords or credit card numbers prevented large-scale
monetary transactions over the Internet. On July 18th of this
year, Netscape Communications, which created the most popular
Internet connection software, announced the release of software
and public protocols to create a "secure digital envelope" for
financial data on the Internet. This means that monetary
information can now be exchanged between customer and business
without fear of interception.  Intuit, Inc. and MasterCard
International are among companies announcing that they will
support the new protocol for securing on-line credit card, debit
card, charge card, and micro-financial transactions.  With this
new technology, the floodgates of Internet commerce are about to
open.

     Obviously, the number of customers with on-line access is
one limit to the growth of on-line sales, but with plans for on-
line connections through local telephone and cable companies,
that is likely to be no more than a few years delay.   The real
hurdle to on-line electronic exchange may end up being less
technological than social:  Scott Cook, chairman of Intuit, Inc.,
notes that changes in fundamental behaviors, such as how people
pay bills, take a very long time.     Cook emphasizes that
Intuit's popular Quicken package has had an electronic payment
facility since 1990, but less than 2 percent of its users pay
bills this way.     "It's hard to get a whole culture to accept a
new payment scheme," he said but, as Intuit's support for
"secure" transactions shows, he expects on-line commerce to
become widespread in the next few years.8

     This means that local and state governments will likely have
a few years to plan before on-line sales significantly explode,
but the effect is likely to come sooner than expected, as most
Internet advances have sped ahead of the most technologically
optimistic predictions.


HOW MUCH MONEY IS AT STAKE?

     State and local governments are now in a cut-throat scramble
with each other to attract high-tech business.  They hope that
new technology companies will replace declining tax bases
decimated by the decline of manufacturing employment.  While
there are likely to be some new jobs, state and local governments
may see little government revenue if present trends continue in
out-of-state and on-line sales which go untaxed.

     Each year, an estimated $200 billion in revenues, most of it
presently free of state sales tax, is generated by mail-order
merchandisers, video marketers, computer-driven sales, credit
card processors and similar companies that typically don't have
regional or local offices.9 The mail order industry has grown
phenomenally in the last few decades. Total mail order sales grew
from only $2.4 billion in 1967 to over $237 billion in sales by
1993. Even accounting for inflation, the growth has been
phenomenal.10


     At the same time, sales taxes have emerged as a big revenue
source for state governments and often an even larger source of
revenue for local governments.  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. Sales taxes often became the revenue of
choice.  De facto, state governments substituted local sales
taxes for federal income tax cuts in the early Reagan years.
Fully 44 states (and the Distr11ict of Columbia) now impose taxes
on retail sales which account for an average of 25 percent of
states' annual income.  With voters increasingly unwilling to
approve higher income taxes and, as in the case of Prop 13, often
legally restrained from raising property taxes, sales taxes have
become the most attractive way to raise local revenue.12

     These two trends_more out-of-state sales and a greater
dependence by local governments on sales taxes_are now on a
collision course.  Even if we ignore smaller out-of-state mail
firms of less than $3 million per year in sales and adjust for
sales taxes that states manage to collect, the U.S. Advisory
Commission on Intergovernmental Relations has estimated that $3.3
billion in sales taxes are lost each year by states.  Nine states
lost over $100 million in 1994 revenue from out-of-state sales,
with California's loss of $483 million topping the list (See
Table 1).  These amounts represent nationally approximately 2.4
percent of total state sales tax collections.13  As mail order
sales grow under the impact of the Internet and other
technologies, the impact is likely to become even more severe.


     For local governments already suffering budget cutbacks, the
effect could be even more devastating.  Silicon Valley, which
helped create the technologies of the Internet and computer
tracking that has allowed the mail order business to boom,
ironically is now one of the most vulnerable local areas in
California to this lost sales tax revenue.  At the county level,
Santa Clara county, which encompasses most of Silicon Valley,
actually outpaces the larger Los Angeles, San Diego, and Orange
Counties not only in the percentage of tax revenue coming from
sales taxes, but Santa Clara actually collects more total revenue
from sales taxes than any of those other counties.

     Cities are even more vulnerable than counties. It is not
surprising that the mayor of Cupertino, where Apple Computer,
Inc. is headquartered, is already worrying about this threat to
his city's finances from on-line commerce: Cupertino depends for
sales taxes for 81 percent of all taxes collected in the city,
making Cupertino one of the most dependent city in California on
sales tax as a revenue source.  Including non-tax revenue sources
such as state aid, fines and service charges for utilities,
Cupertino still depends on sales taxes for 45 percent of its city
revenues.

     In tables 2 and 3, you can see the "Vulnerable 20" Cities
and the "Vulnerable 10" Counties measured by both absolute sales
tax collected and the percentage of local taxes derived from
sales taxes.14



TOTAL TAX LOST BY STATES TO MAIL ORDER
       (TABLE 1)
(STATE BY STATE COMPARISON), 1994
     In Millions of Dollars

State              Untaxed Sales
-----------------  -----------
Alabama            $48.6
Alaska             0.0
Arizona            44.4
Arkansas           19.6
California         482.8
Colorado           47.9
Connecticut        50.4
Delaware           0.0
District Columbia  9.9
Florida            168.9
Georgia            72.9
Hawaii             9.8
Idaho              9.7
Illinois           233.1
Indiana            54.5
Iowa               28.3
Kansas             33.5
Kentucky           41.7
Louisiana          61.9
Maine              13.3
Maryland           60.1
Massachusetts      69.0
Michigan           108.4
Minnesota          53.1
Mississippi        28.0
Missouri           63.5
Montana            0.0
Nebraska           17.4
Nevada             17.4
New Hampshire      0.0
New Jersey         112.2
New Mexico         16.8
New York           359.4
North Carolina     71.1
North Dakota       5.8
Ohio               116.3
Oklahoma           41.8
Oregon             0.0
Pennsylvania       145.0
Rhode Island       14.2
South Carolina     31.3
South Dakota       7.3
Tennessee          68.8
Texas              235.2
Utah               16.8
Vermont            6.0
Virginia           59.9
Washington         76.2
West Virginia      18.6
Wisconsin          46.6
Wyoming            4.4
---------------------                ----------
Total, All States  $3,301.5


Source:  Advisory Commission on Intergovernmental
Relations.  Washington, DC
Taxation of Interstate Mail Order Sales, 1994 Revenue
Estimates

CALIFORNIA COUNTIES MOST  VULNERABLE TO SALES TAX LOSSES, 1993
                  (TABLE 2)

TOP TEN Vulnerable Counties by Total Sales Taxes

          Total Sales Taxes   % of Taxes from
          (millions of $)       Sales Tax
             ----------------    --------------
Sacramento          $95.5          29%
Santa Clara         78.8           17
Los Angeles         75.3           3
Kern                22.9           12
Riverside           21.1           8
San Bernadino       19.2           7
San Diego           17.3           4
Orange              16.4           3
Alameda             12.1           4
Monterey            11.7          16



TOP TEN Vulnerable Counties by Sales Taxes as a
        Percentage of All County Taxes

              % of Taxes from
                 Sales Tax      Total Sales Taxes
             (in Millions of $)
Mariposa            56%            $4.1
Sacramento          29             95.5
Del Norte           25             0.8
Plumas              24             1.7
Mendocino           23             5.6
Trinity             23             0.7
Nevada              21             4.4
Tuolumne            21             3.4
Alpine              20             0.3
Santa Clara         17             78.8


Source:   Municipal Analysis Services, Inc.
Governments of California: 1993 Annual Financial & Employee
Analysis (Austin TX: 1993).



CALIFORNIA CITIES MOST VULNERABLE TO SALES TAX LOSSES, 1993
                    (TABLE 3)

TOP TEN Most Vulnerable Cities by Sales Taxes as a
           Percentage of All City Taxes

               % of Taxes          Total  Sales
               from Sales Tax      Taxes
                                  (millions of $)
                -----------------------
Colma              98%            $4.2
Bellflower          92             5.3
Cupertino           81             9.4
Mammoth Lakes       78             3.1
Capitola            73             3.8
El Cajon            72            14.5
Carmel by the Sea   72             4.4
Ukiah               71             2.3
Lakewood            70             8.0
Hesperia            70             3.2


TOP TEN Most Vulnerable Cities by Total Sales  Taxes

               Total Sales Tax
               (millions of $)     % From Sales
Los Angeles         $778.3         42%
San Francisco       235.7          25
San Diego           193.4          52
San Jose            148.6          46
Sacramento          92.8           59
Long Beach          78.6           49
Oakland             63.8           30
Anaheim             61.0           56
Fresno              51.9           48
Torrance            50.2           64

Source: Municipal Analysis Services, Inc. Governments
of California: 1993 Annual Financial & Employee
Analysis (Austin TX: 1993).



WHY STATES CAN'T COLLECT OUT-OF-STATE TAXES:
     THE QUILL DECISION

     The obvious response to loss of mail-order and Internet
sales would be to allow states to directly tax such sales.
However, the Supreme Court in its 1967 National Bell Hess,
Inc. v. Department of Revenue decision prohibited states from
taxing out-of-state sales based on the Commerce Clause of the
federal Constitution.  Some had hoped that changes in technology
would expand what was considered "in-state" commerce, but in its
May 1992 Quill Corp. v. North Dakota decision, the Supreme
Court reaffirmed that mail-order firms were exempt from state
sales taxes. By creating an extremely tough standard in defining
"in-state" sales, technically called "nexus" in the law, the
Supreme Court made it clear that Internet-based sales will be
treated as out-of-state, tax free transactions.

     In a sense, Quill Corporation at the center of the 1992
decision, exemplifies the danger states face from out-of-state
sales.  Quill is a Delaware corporation with offices and
warehouses in Illinois, California, and Georgia. Quill sells
office supplies, stationery, and equipment, offering over 9,500
different products ranging from paper clips to computers, with
annual sales in excess of $340 million in 1992, making Quill one
of the largest mail order companies in the country, just behind
L.L. Bean and Land's End.15

     Quill solicits business through its numerous catalogs and
flyers, advertisements in nationally distributed "card packs"
and in national periodicals and trade journals, and telephone
solicitation of current customers. Of the more than 200,000
orders that Quill receives monthly, approximately one-half are by
telephone. The remaining half, however, are received by mail,
fax, telex, and by direct computer contact.  Utilizing new
technologies to expand its business,  Quill leased computer
software that permitted customers to have access to Quill's
computer for direct orders.16 Obviously, the Internet will merely
make easier these kinds of on-line commercial transactions

     When the state of North Dakota attempted to impose state
sales taxes on Quill, North Dakota argued that the nature of
direct marketing had created a "ubiquitous presence" in the state
through mail, telephone and electronic solicitation in the state
far beyond what the Supreme Court envisioned when it banned sales
taxes on interstate commerce back in 1967.  In the Quill
decision, however, the Supreme Court upheld its "bright line"
rule that physical presence by company personnel in a state is
required.  This rule is based on the idea that taxes on business
must not interfere with interstate commerce and must be related
to state services provided by the taxing state. Thus, a vendor
like Quill whose only contacts with the taxing state are by mail
or common carrier lacks the substantial "nexus" required by the
Commerce Clause.17

     So, rather than the technologies of direct marketing making
companies more subject to sales taxes, their use of toll-free
numbers, computers, and faxes have allowed direct marketing
companies to dispense with the need for placing sales personnel,
inventory, or showrooms within the state that would establish the
physical presence that would trigger the "nexus" that would allow
states to tax them.  As Internet Web pages located in far-distant
states increasingly replace 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.


BUSINESS AND CONSUMER BURDENS OF MAIL  ORDER SALES TAXES

     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 policy
oriented to more burdensome taxes on business and more intrusive
government on the individual in order to collect those out-of-
state sales taxes.

     In the Quill case, the Supreme Court did leave open the
option that, while states could not unilaterally impose out-of-
state sales taxes, the US Congress could establish such a tax and
remit the proceeds to the respective states.  Senator Dale
Bumpers, D-Ark., was author of The Tax Fairness for Main Street
Business Act of 1994 which would have established such a tax, but
the bill failed in the face of opposition from the Direct
Marketing Association and allied business and consumer groups,
including the American Council of the Blind, Disabled American
Veterans, and the National Alliance of Senior Citizens.18  A
previous bill in 1989, sponsored by Congressman Jack Brooks of
Texas, never made it out of committee. A grass-roots campaign by
the Direct Marketing Association resulted in more than half a
million angry letters to congressmen protesting the proposed
legislation.19

     Forcing companies to collect sales taxes, the argument was
made, would create an unbearable administrative burden.  With 46
states, Washington, D.C., and more than 6,000 counties, cities
and school districts collecting sales taxes (Delaware, Montana,
New Hampshire and Oregon do not collect state or local sales
taxes), the complexity of tracking tax rates in each area and
dealing with local government authorities would overwhelm most
businesses.20  Some argue that the computers that allowed direct
mail to boom could be used to ease the burden of calculating the
tax costs, but the burden of dealing with so many separate
government authorities remains.

     Arnold Miller, treasurer of Quill, argued that dealing with
so many separate authorities leads to the "untold hardship" of
paying deposits, filing 46 quarterly returns, and dealing with
audits.  Miller once worked at  Sears Roebuck and Co. which had
established nexus in 46 states and he notes that Sears underwent
five audits at any one time, in addition to having to file
numerous returns and deposits. But Miller also points out that
Sears could endure this because it could afford twenty-five
professionals who dealt specifically with tax issues.21  And,
while local tax issues were probably not the main reason, Sears
in 1993 discontinuing its mail order catalog in favor of
licensing its database of customers and name to specialty
catalogs like Hanover Direct of Weehawken, NJ., a company which
escapes nexus and thus sales taxes in most states.22

     When Spiegel, the largest catalog direct marketer in the
U.S., recently acquired retailers Honeybee and Eddie Bauer which
gave it nexus in 34 states and felt the additional burden: "You
really do need a lot of computer power," says Spiegel investor
relations officer Debby Koopman. "For example, some states like
Massachusetts and Connecticut exclude clothing mail-order sales
up to a certain amount, say $75. Other states have one rate for
shoes that are classed as clothing and another for shoes that are
classed as athletic equipment."23

     The exact costs of forcing companies to collect sales taxes
in all jurisdictions is unclear, but some estimate that mail-
order companies would incur a ten to twenty percent increase in
operating costs to comply with such legislation,24 while others
note that it costs out-of-state companies at least fifty percent
more to collect the same sales taxes as in-state local retailers.
Studies by Price Waterhouse, Touche Ross and others estimate that
the average cost for an in-state retailer is about 3.4 cents per
tax dollar collected, while the cost to out-of-state merchants is
nearly a nickel. This is aside from the extra audit expenses and
the costs of filing monthly statements to each jurisdiction.25
The worry is that small mail order companies would be driven
under faced by such additional costs.

     Mail order retailers also argue local business are supported
by local sales taxes and it is unfair to tax out-of-state mail
order retailers when they receive no public benefits from those
taxes; this is the argument that ultimately led the Supreme Court
to strike down out-of-state sales taxes. Out-of-state retailers
also worry that if a business is subject to sales taxes, they may
also be considered subject to business license tax and franchise
tax (corporate income tax).

     The other alternative to having retail companies collect
taxes is to have states directly tax consumers as a "use tax" in
place of a sales tax.   States can already legally do this and
they can step up their efforts to collect use taxes directly from
end-consumers. Companies with resale permits in any state are
already required in their routine sales tax audits to prove they
pay tax on everything purchased for their own use. But for
individuals, some states are already using computerized records
from U.S. Customs to bill residents for use tax purchases made
abroad.

     States could also begin collecting information directly from
private sources such as individual credit card and checking
account records. So far none has dared to do this, but
legislators may move in this direction if their sales tax
revenues continue to fall. Some states, like California, prohibit
such actions with strong privacy guarantees in the state
constitution. But in other places, we may have the specter of Big
Brother looking over our shoulders to collect on mail-order
purchases.26



SALES TAXES AND ECONOMIC DEVELOPMENT

     While the pursuit of out-of-state sales taxes are
threatening the economic health of business and the civil
liberties of individuals, local governments have been finding
that the chronic competition for sales tax revenue has begun
undermining local economic development decisions.  The silver
lining of the crisis over out-of-state sales tax losses may be
the abandonment of such wasteful competition.

     The San Jose Mercury News noted in a recent editorial that
"Reliance on sales tax leads some cities to favor building
superstores over industries that offer good-paying jobs. It
discourages cities from adding housing, since more residents mean
more city costs but not necessarily more revenue."  The result is
that cities use business subsidies to compete against other
cities, further draining local revenues overall.  The Mercury
News noted the example of the city of San Jose which desperately
tried to attract a Fry's Electronics and offered Fry's a no-
interest loan that amounts to a $1 million subsidy.27  Greg
LeRoy, author of No More Candy Store, a book about local
government business subsidies, notes that retailers are heavily
subsidized by tax expenditures yet there is little evidence that
these subsidies create new jobs overall; they merely move them
from one location to another.28

     The competition for retail has created an ludicrous
distortion of economic development patterns as cities have had to
desperately bid for successive waves of retail evolution.  First,
shopping in urban centers gave way to downtown retail in the
suburbs.  Then, downtowns began to weaken in the face of
movement to concentrated suburban malls.  Now, general purpose
department stores in malls are giving way to discount "big box"
retailers like Home Depot and Toys'R'Us.  There was once some
expectation that a residential population would generate
proportionate retail revenues. Now, competing cities work to
attract discount giants that suck in business from a whole
region, oftentimes devastating the more dispersed retail that
local governments, especially in the West, depend on for
financing their budgets.  An extreme example is the small city of
Emeryville which has attracted a large number of discount
retailers. Emeryville now has over five times the retail sales
per resident as surrounding cities like Oakland whose own retail
has suffered from the competition.

     Direct marketing through phone, cable or the Internet takes
this economic cannibalism to a new level.  Cities and states are
fighting to attract "call centers" to service direct marketing
companies, since such jobs are seen as non-toxic and "high tech."
To cite one example, Oklahoma has done well in replacing lost oil
patch jobs with telecom-based jobs, but the price has been
massive subsidies to encourage companies to locate in the state.
Oklahoma offers tax incentives, including a law exempting
business from sales tax on 800-numbers, WATS and private line
systems. There is one-stop environmental permitting, tax
exemptions on distribution facilities, and major support for
training and re-training workers. Data processing firms get a
five year property tax exemption.29  In pursuit of jobs, other
states and local areas have created similar subsidies. In the
end, they  merely subsidize the flight of local retail to tax-
exempt mail order.

     Even though all local governments as a whole lose out in
this competition, the hope for the individual areas is that jobs
from such call centers will be long lasting, and the gain in long-
term jobs will offset the cost in local subsidies.  But even that
hope may wither in the face of new technologies.  Bruce
Lowenthal, Tandem Corporations's Program Manager for Electronic
Commerce over the Internet, predicts that the Internet will
eliminate the need for much of the work done by such call
centers.  The Internet will be an "interface" for finding out
what customers need and letting them directly indicate what they
want. Presently, "Such 'interfaces' are done by data entry
clerks," argues Lowenthal.  "So many call centers may be
replaced.  You'll still need some people to deal with hysterical
customers, but that's about it."30  The whole industry of entry-
level data clerks at call centers may melt away, leaving only a
much smaller set of more specialized trouble-shooters. With
companies like Federal Express and Quill allowing business
customers to place orders electronically, the elimination of data
entry positions is already in motion.

     State governments are already fighting to attract electronic
and Internet-based commerce, starting another round of self-
inflicted revenue loss in pursuit.  In 1994, the state of
California quietly passed a law, AB 72 sponsored by Assemblyman
Klehs, that allows out-of-state businesses to advertise on on-
line services based in California without thereby being subject
to state sales taxes.  This law was passed at the request of
Apple Computer,  which feared that it's on-line commercial
service, E-World, would lose out to commercial services based in
other states that could promise tax-free sales in California.
So, even as Silicon Valley cities are losing local tax revenue,
Silicon Valley businesses like Apple Computer's E-World are
leading the way in the hemorrhage of on-line sales tax
revenue.

     Mack Hicks, Vice-President of Electronic Services Delivery
at Bank of America and chair of CommerceNet, summarizes the
economic development logic of the new on-line services:

"If the Bay Area wanted to be the Information area, we should
call ourselves an Information-Tax Free Zone and we'd clean up.
Everyone's trying to figure out how to tax it, because it crosses
borders.  It's too young to tax.  If they tax it, they'll kill
it.   How are you going to tax goods when they're over the
Internet?  You could tax the money, but what if it's bartered.
If I'm in Tennessee, I log onto a server in Ireland, I buy
software with a credit card based in California.  The software is
delivered, which taxes should be paid?  Import taxes, sales tax,
etc.  What a mess."31

So in the competition for a place in the new information economy,
the logic of regional competition promises deep losses in sales
tax revenue as sales move on-line.



SALES TAXES AND THE EFFECTS ON THE POOR

     Another good reason to begin eliminating the sales tax is
simple: sales taxes aren't fair and burden the poor more than the
rich.  Beyond lobbying on behalf of their own economic self-
interest, direct marketers trumpet the burdens on the elderly,
the disabled, and poorer rural residents of taxing mail-order
sales.  While there is a certain cynicism in this "concern" by
the Direct Marketing Association as they have trotted out allies
from the disabled and elderly communities before the US Congress,
there is also a strong truth to their argument that taxing
consumer sales impacts the poor more than anyone else.

     Study after study has shown the regressive nature of sales
taxes as a revenue source.  The most comprehensive study was by
Citizens for Tax Justice in their 1991 A Far Cry from Fair. In
that survey of all taxes collected by local governments, the
report argued that "excessive reliance on sales and excise taxes
is certainly the hallmark of regressive taxation."  Across the
country, the report found that in 1991, the poorest 20 percent of
families were paying 5.7 percent of their income in state sales
taxes, while the richest 1 percent paid only 1.2 percent of their
income in sales taxes--i.e the poor paid nearly five times the
tax rate paid by the rich.  This contrasts sharply with the much
more progressive state income tax. Across the country, the
average state personal income tax for a family of four is only
0.7 percent for the poorest 20 percent of residents and 4.6
percent of the income of the richest 1 percent.32

[GRAPH IN ORIGINAL]

     Because of the regressive nature of sales taxes, those
states that depend on them, such as Washington and Texas, have
the highest tax rates in the country for the poor.  Including in
property taxes--which burden the poor as part of their rent--
total state and local taxes in Washington state were 17.4 percent
of the income of the poorest 20 percent.  Contrast that with
neighboring Oregon, which has a state income tax, where the
poorest 20 percent paid only 9.8 percent of their income in state
and local taxes. The results are clear that depending on sales
taxes lead to the heaviest taxation burdens on those least able
to pay.


POLICY RECOMMENDATIONS:

     The rise of the Internet and other technologies that are
bringing global commerce directly to people's homes are revealing
the limits of the ability of local governments to tax those sales
as they briefly pass through their cities, counties and states.
The end result is either that businesses operating in multiple
states get burdened with tax rules from multiple governments or
individual civil liberties will be eroded as governments record
individual purchases in order to decide which are taxable.

     To respond to the challenges of rising electronic commerce,
the Center for Community Economic Research makes three broad
policy recommendations:

* Centralize revenue collection to the state and national levels

* Scale back and even eliminate sales taxes as a revenue source

*  Prohibit "tax subsidy abuse" by local governments in
  competition for business location


     Centralize revenue collection to the state and national
levels:  Commerce is increasingly national and global, so the
most effective response is for taxation to be done at the state
and, more importantly, at the  national level where possible.
Otherwise, state and local governments engage in a "race to the
bottom" in wasteful tax subsidies and lowered services.  While
this recommendation goes against the general trends of the
country at the moment, it is clear from the fiscal crises facing
cities ranging from Los Angeles to New York City that local
government is finding it almost impossible to sustain a stable
funding base. An additional advantage of centralized revenue is
that it can help erase disparities in services between poor and
rich communities, especially in the area of public education.
Michigan's voters in 1994 approved a new system of school
financing that replaced all local property taxes with a new
combination of statewide taxes that would eliminate many of the
older disparities in local spending. Many other states are
beginning to look at similar centralizations of spending to
eliminate the burdens on local governments.33 To the extent that
spending can be centralized at the national level, many
disparities between states can be eliminated and the competition
between states to lower taxes as an inducement to business
relocation can be reduced.

     Scale back and even eliminate sales taxes as a revenue
source: While centralizing spending at the state level may
ease the burden on local governments, keeping a state sales tax
leaves state finances vulnerable to increased national out-of-
state and Internet-based retail.  In a sense, a sales tax under
the impact of out-of-state and growing Internet-assisted sales is
the worse economic policy possible.  State sales taxes are
essentially an economic tax on local businesses and jobs that
give an economic edge to out-of-state businesses.  Additionally,
state sales taxes still leave the poorest citizens of those
states paying a far higher tax rate than richer citizens.
Property taxes on individuals are usually little more progressive
than sales taxes, so state income taxes are the best replacement
for sales taxes.  With income taxes, states will be able to
equally tax spending and income by individuals, whether spent on
products in-state or bought by mail-order on the Internet.

     Legally prohibit "subsidy abuse" by local governments in
competition for business location:  The best source of
replacement revenue for state and local governments is not new
income but the end of wasteful tax subsidies to attract business.


     Local tax credits and subsidies were once much less
widespread in the US.  In 1977, only nine states gave tax credits
for research and development; by 1993, 34 states did. In 1977,
only eight states allowed cities and counties to lend for
construction, and now 45 do; only 20 states gave low-interest,
tax-exempt revenue-bond loans, now 44 do; only 21 states gave
corporate income tax exemptions, now 36 do.34  In the Federal
Reserve of Minneapolis  economic newsletter, The Region, in March
1995, Melvin Burstein and Arthur Rolnick argue:

     But even though it is rational for individual states to
     compete for specific businesses, the overall economy is
     worse off for their efforts. Economists have found that
     if states are prohibited from competing for specific
     businesses there will be more public and private goods
     for all citizens to consume...In general, it can be
     shown that the optimal tax (the tax that distorts the
     least) is one that is uniformly applied to all
     businesses. Allowing states to have a discriminatory
     tax policy, one that is based on location preferences
     or degree of mobility, therefore, will result in the
     overall economy yielding fewer private and public
     goods.35

A number of states have begun prohibiting cities from using tax
subsidies to lure retail within their borders, and they can
refuse to subsidize "footloose" companies. At least six states,
two cities and Puerto Rico have such rules. Gary, Indiana has the
only ordinance known in the nation which explicitly denies tax
abatements to projects that will relocate jobs from outside the
city limits; the same ordinance denies tax abatements for moves
within the city unless all employees are granted transfer
rights.

     The federal government has contributed to wasteful
relocation subsidies, since its biggest job-subsidy programs,
such as Industrial Revenue Bonds, The Department of
Housing and Urban Development's Community Development Block
Grants, and most Department of Commerce programs, have no rules
against local governments using them to encourage businesses to
relocate. Only two current federal job subsidy programs have such
rules, but states can elude them by using other monies to fund
questionable projects.36 The federal government needs to put
"anti-
piracy" rules in all federal grants to the states and it could
end such job-piracy quickly if it mandated that any state which
engages in interstate job-raiding will lose all of its funding
from Labor or Commerce department agencies for the next fiscal
year.


CONCLUSION:

     As the rhetoric of the Information Superhighway becomes a
reality in our day-to-day lives, we will find that under the glow
of "global opportunities" are real impacts on the physical,
regional, non-global communities we all live within.  Regardless
of the accuracy or inaccuracy of predictions of economic growth
due to the new technologies, there will be specific losses to
specific areas of social life, regional economies and traditional
ways of running our lives and public life.

     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 local revenue.

     The reality is that the rise of national and global commerce
calls for national and even global solutions, regulations and
revenue sources.  While much rhetoric around the new technologies
hearken to images of small firms and decentralization, the
reality is of rising billion-dollar and soon-to-be trillion
dollar corporations straddling the globe. To expect local
governments to devise fair and efficient systems of taxation with
such a disparity in power is senseless.




FOOTNOTES
_______________________________
1 Taxation of Interstate Mail Order Sales: 1994 Revenue
   Estimates,  U.S. Advisory Commission on Intergovernmental
   Relations.  (Washington, D.C.: 1994), SR-18.
2 Interview with Wally Dean, April 5th, 1995.
3 Carroll, J A.       "Wired to the world."     CA Magazine v126,
   n7 (Aug 1993):28-31.
4 Interview with Mark Masotto 6-13-95
5 Horwitt, Elisabeth.   "It ain't no superhighway."
   CommunicationsWeek, n547 (Mar 13, 1995):S23-S24.
6 Watson, Tom.   "Click here for a slab of peanut pie."
   Restaurant Business v94, n5 (Mar 20, 1995):15-18
7 Masotto, Ibid
8 Booker, Ellis.     " 'Net to reshape business." Computerworld
   v29, n11 (Mar 13, 1995):14
9 Srodes, James.  "Murdering Mail Order."  Financial World v161,
   n7 (Mar 31, 1992):64-67.
10 O'Connell, Daniel.  "U.S. Supreme Court Reviews State and
   Local Taxation Issues." CPA Journal v62, n3 (Mar 1992):16-
21.Page: 4
11 Add etc.
12 Srodes, James.  "Murdering Mail Order."  Financial World v161,
   n7 (Mar 31, 1992):64-67.
13 Taxation of Interstate Mail Order Sales, Ibid
14 Figures are from Municipal Analysis Services, Inc. Governments
   of California: 1993 Annual Financial & Employee Analysis
   (Austin TX: 1993).  Note that San Francisco is ranked only
   with other cities.
15 Taxation of Interstate Mail Order Sales, Ibid
16 O'Connell, Ibid.
17 Genetelli, Richard W.; Zigman, David B.; Bencosme, Cesar E.
   "Recent U.S. Supreme Court Decisions on State and Local Tax
   Issues." CPA Journal v62, n11 (Nov 1992):38-44.
18 Gattuso, Greg. "Tax Fairness Act unfair: DMA." Direct
     Marketing   v57, n2 (Jun 1994):6.
19  Glass, Brett.  "The Real Cost of Mail-Order PCs." InfoWorld
    v13, n48 (Dec 2, 1991):45-46.
20 Gattuso, Greg.   "Tax Fairness Act unfair: DMA."   Direct
   Marketing v57, n2 (Jun 1994):6.
21 Glass, Brett. "The Real Cost of Mail-Order PCs."  InfoWorld
    v13, n48 (Dec 2, 1991):45-46.
22 Miller, Cyndee. "Catalogs alive, thriving."  Marketing News
    v28, n5 (Feb 28, 1994):1,6.
23 Srodes, James.  "Murdering Mail Order."  Financial World v161,
   n7 (Mar 31, 1992):64-67.
24 Gwaltney, John R.  "Fallacies of Sales-Tax Loophole for Mail-
   Order Firms."  Small Business Reports v15, n4 (Apr 1990):26-
   29.
25 Srodes, James, Ibid.
26 Glass, Brett. "The Real Cost of Mail-Order PCs. " InfoWorld
      v13, n48 (Dec 2, 1991):45-46.
27 Editorial. "Tax Facts The System Sets Cities Up To Be Squeezed
   By Superstores", San Jose Mercury News, July 24, 1995
28 Leroy, Greg.  "No more candy store: states move to end
   corporate welfare as we know it."   Dollars & Sense, n199
   (May-June, 1995):10 (5 pages).
29 Harler, Curt. "Why Governments Want Your Network Center."
   Communications News v29, n12 (Dec 1992):30.
30 Interview with Bruce Lowenthal, Tandem, 7-21-95.
31 Interview with Mack Hicks, June 22, 1995.
32 Citizens for Tax Justice. A Far Cry From Fair: CTJ's Guide to
   State Tax Reform (Washington DC: April 1991).  A joint project
   with the Institute for Taxation and Economic Policy.
33 Courant, Paul N; Gramlich, Edward M; Loeb, Susanna.  "
   Michigan's recent school finance reforms: A preliminary
   report."   American Economic Review v85, n2 (May 1995):372-
   377.
34 Leroy, Greg.  "No more candy store: states move to end
corporate welfare as we know it."   Dollars & Sense, n199 (May-
June, 1995):10 (5 pages).
35 Burstein, Melvin L; Rolnick, Arthur J.  "Congress should end
the economic war among the states."   Federal Reserve Bank of
   Minneapolis: The Region v9, n1 (Mar 1995):3-20.
36 Leroy, Greg.  "No more candy store: states move to end
corporate  welfare as we know it."   Dollars & Sense, n199 (May-
June, 1995):10 (5 pages).