April 17, 2007

The Useless Use Tax

Today's edition of The Tennessean has three stories on the state's "use" tax, the sales tax-equivalent that the state levies on items that individuals and businesses buy from merchants in other states and bring into Tennessee - or order by phone or Internet and have shipped in. If you buy something in, say, Texas, and bring it into Tennessee - or order something over the Internet and have it shipped in, you are supposed to pay Tennessee's sales tax on it. If the online retailer doesn't charge you the tax, you're supposed to contact the Department of Revenue and pay the the identical "use" tax on your purchase. Few people actually do that.

You can read the main story, and see links to the sidebars, here. Yet in all that copy The Tennessean missed the real story, which is this: The wild scare-mongering predictions that economists at the University of Tennessee were making just a few years ago of huge amounts of lost revenue due to online sales - predictions made to help prop up the push for a state income tax - have turned out to be wrong.

In this story today, The Tennessean mentions a 2004 study by economists at the University of Tennessee Center for Business and Economic Research which asserted that Tennessee will lose an estimated $612.5 million in 2008 on uncollected use taxes from Internet, catalog and other "remote" sales including $335.7 million lost on sales over the Internet.

The number is, most assuredly, bunk, as $335 million in unpaid sales taxes would equate to the average Tennessee family of four spending nearly $3,600 per year online.

The 2004 study from UT was merely one in a string of studies that the UT economists, primarily Dr. Bill Fox, had issued on the subject of Internet sales and "lost" tax revenue in recent years. In 2002, Dr. Fox and the UT-CBER issued a report claiming Tennessee was losing $300 million a year in sales tax revenue because of online sales.

The assertion was easily debunked:

Then, in late 2003, a study by the Direct Marketing Association was published that contradicted and criticized the series of University of Tennessee studies forecasting sales tax revenue losses due to e-commerce. The DMA said 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."

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.

One other factor: Increasingly, online purchases are made at the websites of national retailers who have stores or other facilities in the state and who, therefore, collect the state's sales tax.

In July 2004, Dr. Fox began to climb down from his previous sky-high estimates of revenue losses from online sales. The mainstream media missed it, but I documented it here. In 2001, Fox and the UT-CBER forecast states would lose a combined $45.2 billion in 2006. But by 2004, Fox and the UT economists had reduced their projection for 2006 to combined losses of $19.2 billion. The 2004 report - which is the one The Tennessean referenced today - still relied on estimates from Forrester Research, as did his earlier forecasts, rather than actual e-commerce data from the U.S. Census Bureau - data which has proven to be more accurate. But the Tennessean neither spotted Fox's climb-down in 2004, and didn't report the DMA study's criticisms back then either - and still continues to use the highly dubious $300 million figure.

When Dr. Fox and the UT economists use actual data rather than Forrester Research estimates, you can take their numbers seriously. Until then, neither their reports nor the media coverage of them that ignores contradictory research should be taken seriously.

Today's package of Tennessean stories also raises another question about the "use" tax - a question of fairness.

As The Tennessean reveals today, the state does not collect the tax uniformly nor have a method for doing so. That makes the tax random and unfair and, as I see it, potentially a violation of the equal protection clause of the U.S. constitution.

Unlike the sales tax, which is collected automatically by merchants on every sale, the state has no uniform pro-active method for collecting the use tax from all Tennesseans who owe it. Why doesn't the state collect it from everyone? They can't. As The Tennessean reported today:

The U.S. Supreme Court has ruled that companies aren't required to collect the tax on Internet and catalog sales except in states where they have a store or other facility. That leaves states with the task of trying to collect the tax directly from consumers. Online sales aren't reported to anyone, so states don't have an easy way to discover who has purchased goods online.

The tax is unfair, impossible to collect, generates very little revenue for the state, and is less and less relevant as more and more e-commerce is transacted at the websites of national retailers that have a physical presence in the state and, therefore, collect the sales tax. With Tennessee now running routine large revenue surpluses - this fiscal year's surplus is likely to top $350 million - the "use" tax on personal purchases is something the state could easily do without.