UT Faculty Discusses The Cost of Tax-Free Online Shopping


By Whitney Heins

When you make an online purchase from a company that does not collect sales tax, you probably don’t think much beyond the roughly 10 percent you just saved.

But if you are economist Bill Fox, you see that tax-free purchase through a different lens. You see that purchase as having the potential to shutter traditional brick-and-mortar retailers, cost Americans jobs, contribute to states’ financial deficits, and breed inefficiencies in the nation’s overall economy.

“Taxes and prices influence behavior,” says Fox, UT economics professor and director of the Center for Business and Economic Research. “The notion is that if we have two similar goods and services that are treated differently for tax purposes, then we are incentivizing the one that is tax-favored.”

Today, some online sales are not taxed due to the 1992 US Supreme Court decision Quill v. North Dakota, which says only companies with a physical presence in a state, like a store or office, are required to collect taxes from buyers in that state. The goal was to keep companies from having to contend with more than 6,000 separate sales and use tax jurisdictions, thereby imposing a crushing burden that would severely restrict interstate commerce.

Restricting interstate commerce was implicitly outlawed in the US Constitution’s Commerce Clause. Since most catalog and online purchases are made through out-of-state vendors, it is currently up to the buyers to calculate the sales tax they owe and voluntarily report it. (But really, how many of us do this? Fox estimates probably less than 5 percent, though businesses are much more likely to comply on their purchases.)

Fox began researching the online sales tax issue back in 1996, when most people were still shopping in stores and from catalogs. He peered into the issue at all angles—with the goal of trying to determine how the tax treatment is impacting the US economy.

Flash forward fifteen years, and online sales tax has become a hot-button issue in many state legislatures across the country. Some cash-strapped states are now trying to impose an online sales tax to create new revenue streams, and many of them are becoming embroiled in bitter battles with online retail giant Amazon. Fox’s research has influenced states’ policy, and his name appears almost daily in the media on the topic.

The US economy may be hurting, but e-commerce sales are soaring. Based on the Census Bureau’s E-Stats data, Fox estimates that since 1996, a total of $3.5 trillion—or one out of every six dollars spent in the U.S.—has been spent online. Ninety percent of these sales are between businesses.

How much money are the states losing? Fox and his research team compiled the estimate of e-commerce sales allocated by state data with a survey of all US departments (of which thirty responded), which determined what share of sales is taxable. They then multiplied it by the tax rate to determine what the taxes for the forty-five sales-taxing states would be. Then they estimated how much sales tax revenue is collected using vendor reports and estimated that use taxes are collected at a liberal 5 percent rate. (A use tax is levied when the products are purchased from a different state paying the sales tax to that state.This tax compensates the state where the goods are finally put to use).

According to Fox’s calculations, states are owed $51 billion in sales tax on e-commerce but are losing $12 billion due to noncompliance in the current fiscal year. This loss of revenue has deep implications for states not merely because they are missing it, but because it is shifting out of their coffers as more transactions move online.

“It becomes a spiraling problem,” Fox says. “Because the states don’t collect from online retailers like Amazon, they can either raise taxes or cut their government to make up for their revenue shortfalls. If they raise taxes, that motivates people to do more shopping online.”

Fox's research found Wal-mart has just over five employees per $1 million in sales while Amazon has only one.  
Fox’s research found Wal-mart has just over five employees per $1 million in sales while Amazon has only one.  

Fox is also investigating how the tax treatment could be influencing consumer habits and contributing to job losses. He already has made the alarming discovery that e-commerce is draining the economy of jobs. Drawing from Internet500 and Bloomberg data for online retailers and brick-and-mortar businesses, Fox and his co-author, Don Bruce, looked at sales and employment, analyzing e-commerce sales as firms moved online and the effect it had on the number of employees.

He found that the average retail firm has about four workers per $1 million in sales, but that number slightly reduces by 0.03 percent for every 1 percent of sales made online. That sounds like an insignificant amount, but when a company goes completely online, it employs three fewer workers per $1 million. Anecdotally, Amazon employs one worker per $1 million in sales. Compare that to Walmart, which employs 5.2 workers per $1 million in sales.

“You have two production technologies to do work—one in the store and the other is where you order it online. One uses a lot of workers; the other doesn’t,” says Fox. “I don’t have a favorite. Consumers should decide what they want. If the tax is moving people over from the store to online, then the tax is moving people to the low-employment technology. If the tax has no influence, then who cares? But if the tax is shifting people, then it is costing America jobs. That is what we are trying to study.”

Consumers are not the only ones potentially changing their habits because of the tax law—so are businesses. Amazon has relocated distribution facilities allegedly not because it was better for business, but because of pending online sales tax legislation. Similarly, another trend Fox is currently investigating is grand-scale tax evasion by businesses that purchase goods from different states to avoid their own high sales tax. Studying the Department of Commerce’s commodity flow data, which tracks commodities between states, Fox and his co-authors have found the propensity for firms to trade more across long distances, particularly to those states with high tax rates.

“All these behavioral changes have an effect on how the US economy operates,” Fox says. “They are making our economy inefficient by moving business to a state that is not the best place to operate, or purchasing goods outside the state in which your business resides, and shipping the goods hundreds of miles that it does not need to travel.”

So what is the solution? Some of Fox’s research has been conducted for the Streamlined Sales Tax Project, a group formed by forty-four states and the District of Columbia with the goal of implementing a streamlined sales tax collection process. This new process would remove the so-called burden inhibiting interstate commerce as stated in the Quill v. North Dakota decision. While a streamlined sales tax would not stop the effects of e-commerce, it would level the playing field, Fox suggests. Congressional action may ultimately be necessary to fully implement the streamlined sales tax that requires remote firms to collect sales taxes for states.

“I want what is going to happen, to happen through natural economic forces, not through public policy because when public policy decides winners and losers, it always gets it wrong,” Fox says. “I want the economy to figure this out. Not differential taxation.”

About University of Tennessee

Haslam College of Business, University of Tennessee, Knoxville TN
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