The Truth About Online Sales Taxes: New Analysis Based on Department of Commerce Data Demonstrates Previous Studies Are Unreliable as the Basis for Congressional Action

WASHINGTON, DC, March 13, 2003 – The Direct Marketing Association (The DMA) in conjunction with online, offline and catalog companies today announced the release of a groundbreaking new analysis, based on U.S. Department of Commerce data, demonstrating that previous proclamations about the amount of potential state tax losses due to online sales were, at best, wildly overstated.

The analysis released today, entitled "A Current Calculation of Uncollected State Sales Tax Arising from Internet Growth," clearly shows that potential uncollected revenue to the states is about 85 percent less than compared to prior studies. For example, in 2001, the states reported that approximately $13 billion went uncollected due to their inability to force out-of-state retailers to act as their unpaid tax collectors. In fact, the total amount potentially uncollected was about $1.9 billion.

Much-cited studies from the University of Tennessee erroneously relied on data from the Internet boom years and made flawed assumptions about e-commerce that resulted in their vast over-estimates. Among these were:

• Internet growth rates of 38 percent annually – which might have seemed plausible during the dot.com bubble era, but which subsequent economic experience has invalidated.
• Failure to separate B-to-B Internet activity from pre-existing B-to-B e-commerce

• Excessively low rate of business compliance on sales tax remittance
• Failure to note decline of "pure-play" e-tailing in favor of bricks-and-clicks

All of these factors resulted in excessively high estimates of how much the states were losing financially from Internet sales. These grossly inflated numbers, in turn, have been used to manufacture a political crisis aimed to persuade Congressional lawmakers to overturn 227 years of Interstate Commerce Clause tradition and law.

"It is imperative that if Congress considers overturning the long and successful history of the Interstate Commerce Clause, thereby inflicting harm on American consumers and businesses, it do so based on facts derived directly from an institution like the U.S. Department of Commerce," said H. Robert Wientzen, president & CEO, The DMA.

"The analysis of Internet economic activity in America that we released today demonstrates without a doubt that there is – despite what a lot of state politicians are claiming – no pot of gold for the states in creating new burdens for remote retailers," Wientzen said.

"While the issue of state budget deficits is real, federal policymakers should not be misled into thinking that the states’ fiscal crisis was caused by uncollected remote sales tax," Wientzen said, pointing out that, "in fact, the last time the states came knocking on Congress’ door asking for the power to force out-of-state businesses to collect states’ sales taxes, most of them were running record surpluses.".

"Furthermore, the so-called simplification proposal that the states have been trying to pass – in the hopes of winning Congressional support – is anything but simple," Wientzen said.

In addition, the states have had since 1967 to reduce the cumbersome number of taxing jurisdictions standing in the way of their expressed desire to force out-of-state merchants to collect and remit state sales taxes on their behalf. However, since that time, the number of taxing jurisdictions has ballooned from 2,300 to 7,600.

"If the past is indeed prologue here, there is no reason to believe that the states can achieve meaningful simplification, and there is very real reason to believe that – in their desire to jump on the Internet sales tax bandwagon – the number of taxing jurisdictions in the United States will continue to proliferate," Wientzen commented.

It is important to note that the current system gives the states all necessary authority to collect sales and use taxes from their own citizens without an act of Congress. What the states now are seeking in Congress will lead to burdensome costs and administrative complications that, ultimately, will be shouldered by consumers at a time when the economy can least afford them.

"Some estimates suggest that the yet-to-be-developed software for almost every business in American to manage its cumbersome obligations to 7,600 taxing jurisdictions could cost $25,000 per license and $60,000 for set up. Moreover, most businesses would have to create departments and hire staff in order to comply with all of the states tax codes and rules. The states are simply asking for too much from businesses who are trying to weather today's economic doldrums," said Wientzen.

Recent announcements about nationwide retailers voluntarily agreeing to collect and remit states’sales taxes is simply a practical business decision on their parts. In exchange for voluntarily collecting these taxes -- something they may have been legally obligated to do anyway – they achieved two important goals: 1) amnesty for any past taxes owed, and 2) integration of their online and offline businesses.

"In their determination of what they might gain from the Internet, it is incumbent on state policymakers and their Congressional representatives not to be influenced by specious claims concerning the Internet and e-commerce growth," said Peter A. Johnson, Ph.D., senior economist, The DMA, the author of today’s study.

• Is there a crisis?
• If states claim there is a policy emergency arising from the growth of e-commerce, the best available growth rate numbers (Census Bureau data from the Department of Commerce) show a very different picture. If there is a leak to state treasuries at all, it is growing only incrementally. As one e-commerce expert recently observed, "the idea of incremental change is not a sexy concept that can be hyped at every turn. But most experts likely would agree that low but stable growth rates are better for the economy than the wild highs and lows seen in recent years." They also provide a more reasonable basis for evaluating tax policy.

• What is E-Commerce? Confusion Multiplied by Hype
• One of the symptoms of excessive Internet exuberance was that few people stopped to ask what e-commerce actually meant, or how new it really was. Consequently, the University of Tennessee authors overlooked the fact that much of what they were counting as "new" e-commerce in B-to-B transactions was actually decades-old supply-chain purchases over Electronic Data Interchange and other proprietary networks. As these are irrelevant to the question of the Internet and the definition of nexus, as much as 80 percent or more of the Tennessee study’s over-counting arises from this confusion about what e-commerce actually is.

• Ultimately, if the states have reason to believe that businesses are not sufficiently in compliance, they have the authority under the existing definition of nexus to audit them more thoroughly. Indeed, at the end of the day, the question of B-to-B e-commerce and compliance rates may be irrelevant to the question of changing the definition of nexus, since the states currently have all the legal tools they need to make B-to-B use tax remittances comply with the law.
  

• Misperceptions about dog food and other e-retail problems
• The misperception of a rush to substitute interstate sales for in-state sales arose for the same reason as the perception of growth in e-commerce generally. There was a failure to ask consumers "if they were going to make a mad dash to the Internet to buy items like dog food, plants, and furniture. As a result, many pure-play e-tailers selling such items ended up on the dot-com scrap heap. Demand simply did not materialize."
  

• European Union and Others Are Eager to See If States Get Their Way
• It is certainly possible that changing the definition of nexus could be a Pandora’s box, with unforeseen consequences for domestic and international economic policy. If Paris, Texas, is allowed to tax out-of-jurisdiction sellers, could our economic trading partners use this as a precedent during future rounds of multi-lateral trading negotiations? As University of Chicago economist Austan Goolsby has observed, "European officials will face a powerful temptation when it comes to taxing Internet commerce. The majority of online merchants are located in the United States. There will be increasing pressure to put special taxes on e-commerce that will disproportionately affect U.S. merchants competing with domestic [i.e., non-U.S.] retailers."

The DMA is the leading trade association for businesses interested in interactive and database marketing, with nearly 4,700 member companies from the United States and 53 other nations. Founded in 1917, its members include direct marketers from every business segment as well as the nonprofit and electronic marketing sectors. Included are catalogers, Internet retailers and service providers, financial services providers, book and magazine publishers, book and music clubs, retail stores, industrial manufacturers and a host of other vertical segments, including the service industries that support them. According to a DMA-commissioned study, direct and interactive marketing sales in the United States are projected to have surpassed $2 trillion in 2002, including $126 billion in catalog sales and $34 billion in sales generated by the Internet. The DMA's Web site is www.the-dma.org, and its consumer Web site is www.shopthenet.org.

The analysis released today, entitled "A Current Calculation of Uncollected State Sales Tax Arising from Internet Growth," will be available at today's press conference at The National Press Club at 9:30 AM EST. It will also be available online at the conclusion of the press conference at http://www.the-dma.org/taxation/

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