Thomas A. Garrett

English

Research Papers in Economics

NationalEconomicTrends
January 2003
Taxing Electronic
Commerce:
Boon or Boondoggle?
The recent economic slowdown—combined with
pervasive state tax cuts in the 1990s—has hit state budgets
hard. State tax collections, particularly income taxes on
capital gains, were down by nearly 8 percent in FY 2002
and are expected to continue falling during FY 2003.
States’ budget deficits for FY 2002 totaled $37 billion.
Even with over $17 billion in states’ rainy day funds,
estimates for FY 2003 forecast a collective budget deficit
of nearly $50 billion.1
Many state policymakers believe that taxing electronic
commerce—retail purchases conducted via the Internet—
offers a partial remedy for their current fiscal crises.
The U.S. General Accounting Office has estimated that
the potential annual sales tax revenue to states from
online taxation is $13 billion. In 1992, however, the
U.S. Supreme Court ruled that—under current law—
merchants cannot be required to collect sales taxes unless
they have a physical presence in the state where the cus-
tomer is located. At the same time, the Court also ruled
that Congress has the authority to amend the law and
permit states to require that remote sellers collect and
remit sales taxes.
Recently, policymakers from 30 states agreed to a
proposal to simplify their sales tax laws and to encourage
voluntary collection of online sales taxes. Named the
Streamlined Sales Tax Project, this proposal would take
effect when ten states representing 20 percent of the U.S.
population have amended their laws to begin the program.
Participating states would then ask Congress to vote in
favor of a mandatory nationwide online sales tax collec-
tion program. The proposal would require states to adopt
uniform definitions for various taxable goods and imple-
ment a statewide tax rate for each good. Online sellers
would be required to purchase software that computes
the appropriate tax rate for the buyer’s location. Sellers
would then remit the collected sales tax to the correspond-
ing state’s treasury. Although states claim they would gain
much-needed revenues and that online taxation would
achieve more equitable tax treatment across Internet and
local retailers, online retailers argue that costs from
compliance and tax collection for over 7,000 different tax
jurisdictions in the United States would be enormous.
Despite the possible costs, is taxing electronic com-
merce a permanent solution to states’ budget problems?
History suggests not, as states have continually sought
new sources of revenue. Many states adopted sales taxes
in the 1950s and 1960s and many have increased rates
nearly 200 percent since that time. States receive hundreds
of millions of dollars annually from lotteries and casino
gambling taxes. States are now dipping into their tobacco
settlement revenues to fund programs not remotely related
to health care and smoker education. Finally, all but nine
states have adopted rainy day funds, although many
states have balances less than 5 percent of general fund
revenue. None of these revenue sources has prevented
the current budget problems.
During economic booms, such as the 1990s, state
lawmakers cut tax rates while tax coffers are flush and
make additional expenditure commitments that they have
difficulty keeping when the economy slows. As economic
conditions improve, states will again see rising revenues.
If the past is a guide, these revenues will be committed
to ongoing spending programs or tax rates will be cut.
The single step of taxing electronic commerce is no
panacea to the procyclical spend/cut pattern of state
governments. Regardless of whether states end up taxing
electronic commerce, state lawmakers could moderate
spending growth and tax cutting during favorable econ-
omic conditions and contribute more surplus revenues
to rainy day funds.
—Thomas A. Garrett
1National Conference of State Legislatures, State Budget and Tax Actions
2002, and House Research Organization, Texas House of Representatives,
Interim News, 25 March 2002.
Views expressed do not necessarily reflect official positions of the Federal Reserve System.
research.stlouisfed.org

Taxing electronic commerce: boon or boondoggle?

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Taxing electronic commerce: boon or boondoggle?

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