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

August 1995


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

Policy Recommendations:



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
(510) 452-1820


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:

Roots of the Crisis:

The Burdens on Local Government from the Sales Tax:


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.

Center for Community Economic Research

c/o 2521 Channing Wy. Berkeley, CA 94704 (510) 643-8293 *

"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:


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.


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



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


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).


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).


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.


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


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:

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.


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

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.


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:

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.


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.

4Interview with Mark Masotto 6-13-95
5Horwitt, Elisabeth. "It ain't no superhighway." CommunicationsWeek, n547 (Mar 13, 1995):S23-S24.
6Watson, Tom. "Click here for a slab of peanut pie." Restaurant Business v94, n5 (Mar 20, 1995):15-18
7Masotto, Ibid
8Booker, Ellis. " 'Net to reshape business." Computerworld v29, n11 (Mar 13, 1995):14
9Srodes, James. "Murdering Mail Order." Financial World v161, n7 (Mar 31, 1992):64-67.
10O'Connell, Daniel. "U.S. Supreme Court Reviews State and Local Taxation Issues." CPA Journal v62, n3 (Mar 1992):16-21. 11Add etc.
12Srodes, James. "Murdering Mail Order." Financial World v161, n7 (Mar 31, 1992):64-67.
13Taxation of Interstate Mail Order Sales, Ibid
14Figures 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.
15Taxation of Interstate Mail Order Sales, Ibid
16O'Connell, Ibid.
17Genetelli, 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.
19Glass, Brett. "The Real Cost of Mail-Order PCs." InfoWorld v13, n48 (Dec 2, 1991):45-46.
20Gattuso, Greg. "Tax Fairness Act unfair: DMA." Direct Marketing v57, n2 (Jun 1994):6.
21Glass, Brett. "The Real Cost of Mail-Order PCs." InfoWorld v13, n48 (Dec 2, 1991):45-46.
22Miller, 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.
24Gwaltney, John R. "Fallacies of Sales-Tax Loophole for Mail- Order Firms." Small Business Reports v15, n4 (Apr 1990):26- 29.
25Srodes, James, Ibid.
26Glass, Brett. "The Real Cost of Mail-Order PCs. " InfoWorld v13, n48 (Dec 2, 1991):45-46.
27Editorial. "Tax Facts The System Sets Cities Up To Be Squeezed By Superstores", San Jose Mercury News, July 24, 1995
28Leroy, Greg. "No more candy store: states move to end corporate welfare as we know it." Dollars & Sense, n199 (May-June, 1995):10 (5 pages).
29Harler, Curt. "Why Governments Want Your Network Center." Communications News v29, n12 (Dec 1992):30.
30Interview with Bruce Lowenthal, Tandem, 7-21-95.
31Interview with Mack Hicks, June 22, 1995.
32Citizens 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.
34Leroy, Greg. "No more candy store: states move to end corporate welfare as we know it." Dollars & Sense, n199 (May-June, 1995):10 (5 pages).
35Burstein, 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.
36Leroy, Greg. "No more candy store: states move to end corporate welfare as we know it." Dollars & Sense, n199 (May-June, 1995):10 (5 pages).