March 14, 2003

Online Sales-Tax Losses Are Overstated, Study Says

That kaboom you hear is the sound of a myth being exploded.

U.S. states lost $2.8 billion last year in uncollected Internet sales taxes, which is much less than previously estimated, according to a new study released this week. The study, by the Direct Marketing Association, contradicts and criticizes a series of University of Tennessee studies that had predicted much higher losses of sales tax revenue due to e-commerce. Those UT studies confused different types of online transactions and relied on fuzzy numbers and wildly-exaggerated estimates to arrive at its inflated figure.

The amount of potential revenue that cash-strapped states are missing out on has been grossly overstated, says Peter Johnson, a DMA economist. "The Internet is not creating a massive leak in state coffers."

The DMA report estimates the states will miss out on $4.5 billion in tax revenue in 2011. The University of Tennessee economists had previously estimated that states will lose $54 billion. That's a difference of nearly $50 billion.

Why is UT's much-higher - and much-hyped - estimate wrong? UT's studies used sales estimates compiled by Forrester Research at the height of the dot-com bubble, while the DMA used actual sales figures compiled by the Commerce Department and relied on a more conservative growth estimate, the report said.

You can read the DMA's economic study for yourself. It is groundbreaking new analysis, based on U.S. Department of Commerce data, which proves that previous claims for the amount of potential state tax losses due to online sales were, at best, wildly overstated.

The analysis, 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 predicted in prior studies. In 2001, for example, the states claimed that approximately $13 billion went uncollected due to their inability to force out-of-state retailers to act as their unpaid tax collectors, while 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 ecommerce that resulted in their vast over-estimates," says the DMA. Among the flaws in the UT studies:

1. Assuming 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.
2. Failing to separate business-to-business Internet activity from pre-existing business-to-business ecommerce
3. Using an excessively low rate of business compliance on sales tax remittance
4. Failing to note the decline of "pure-play" online retailing in favor of bricks-and-clicks.

Regular readers know I am often critical of attempts to tax online sales, based on constitutional and other objections. And I long ago dismissed the UT study's estimate as inaccurate hype. In fact, here is a link to the first things I ever posted on this blog. They're about online sales taxes. And here's one of the most recent.

The DMA study is a bombshell, destroying a myth that has persisted for several years because of a deeply flawed study published by the University of Tennessee. We in Tennessee long ago learned to be suspicious and skeptical of any tax-related economic research that comes out of the University of Tennessee, especially if it has Dr. Bill Fox's name on it - which UT's sales tax study does - because of Fox's laughably bad track record of forecasting economic growth and tax revenues in Tennessee over the past decade. Now, the rest of the country is starting to learn the same thing.

The WaPo story today on the DMA study points out that the UT study was bought and paid for funded by the Institute for State Studies, a Utah-based think thank that favors online sales taxes. The ISS was founded by Utah Gov. Michael Leavitt (R), one of the leading figures lobbying for mandatory Internet sales taxes. As I've reported here before, the ISS has links to the Streamlined Sales Tax Project, which is itself an arm of the National Governors Association. The three groups favor online sales taxes. As they were paying for the study, you can't blame Fox and his crew for obliging the client with a report that appears to support the client's pre-determined position.

The good news is, it no longer stands alone as the definitive study. The DMA study has blown a giant hole in the carefully crafted myth.