State and Local and Use Taxes and Internet Commerce

CRS Report for Congress
State and Local Sales and Use Taxes and Internet
Co mmerce
Updated March 9, 2006
Steven Maguire
Government and Finance Division

Congressional Research Service ˜ The Library of Congress

State and Local Sales and Use Taxes and Internet
In theory, state sales and use taxes are consumption taxes based on the
destination principle. The destination principle prescribes that taxes should be paid
where the consumption takes place. Sales taxes collected at the point of sale achieve
this if consumption takes place near the point of transaction. Thus, to remain
consistent with the destination principle, consumers pay a use tax on products
purchased out-of-state and used in their home state where consumption likely takes
Under current law, states cannot reach beyond their borders and compel out-of-
state vendors (without nexus in the state) to collect the use tax owed by state
residents. The Supreme Court has ruled that requiring remote vendors to collect the
use tax would pose an undue burden on interstate commerce. States are concerned
because they anticipate gradually losing more tax revenue as the growth of Internet
commerce allows more residents to buy products from vendors located out-of-state
and evade use taxes. Recent estimates put this loss at approximately $8 billion in
2003. For this report, “Internet taxes” are existing use taxes and taxes on Internet
access services. States that rely more heavily on the sales and use tax will likely lose
more revenue than states less reliant on the sales and use tax. Congress is involved
in this issue because commerce conducted by parties in different states over the
Internet falls under the Commerce Clause of the Constitution.
A related issue is the “Internet Tax Moratorium.” The moratorium prohibits (1)
new taxes on Internet access services and (2) multiple or discriminatory taxes on
Internet commerce. This moratorium was created by the Internet Tax Freedom Act
(ITFA) of 1998 and had expired on October 21, 2001. Congress extended the
“Internet Tax Moratorium” through November 1, 2003, with P.L. 107-75, enacted on
November 28, 2001. The moratorium was extended for an additional four years,
through November 1, 2007, by P.L. 108-435, enacted on December 3, 2004. The
moratorium is related to the use tax collection issue, but is distinct from the remote
collection issue.
The degree of further congressional involvement in the remote collection issue
is uncertain. Opponents of remote vendor use tax collection responsibility generally
support a clearer definition of nexus for use tax purposes. Many state officials would
like Congress to change the law and allow states to require out-of-state vendors
without nexus to collect state use taxes. Simplification and harmonization of state
tax systems are likely prerequisites for Congress to consider approval of increased
collection authority for states. This report will be updated as legislative events

In troduction ..................................................1
Overview ....................................................1
A Brief History of the Sales and Use Tax.......................1
What Are “Internet Taxes”?..................................2
Two Components of the Sales and Use Tax.........................3
Tax Base.................................................4
Tax Rate.................................................4
Internet Taxes: Economic Issues..................................5
Efficiency ................................................6
Equity ...................................................7
Differential Effect Among States..............................7
Revenue Loss Estimates....................................8
Policy Options................................................8
Active Approach..........................................9
Passive Approach..........................................9
List of Tables
Table 1. State and Local General Sales and Gross Receipts Taxes as Percent
of Total Personal Income, by State, FY2002........................10
Table 2. State and Local Reliance on the Sales and Gross Receipts Tax,
by State, FY2002.............................................12

State and Local Sales and Use Taxes and
Internet Commerce
State governments rely on sales and use taxes for approximately one-third
(33.4%) of their total tax revenue — or approximately $198 billion in FY2004.1
Local governments derived 11.4% of their tax revenue or $44.6 billion from local
sales and use taxes in FY2003.2 Both state and local sales taxes are collected by
vendors at the time of transaction and are levied at a percentage of a product’s retail
price. Alternatively, use taxes are often not collected by the vendor if the vendor
does not have nexus (loosely defined as a physical presence) in the consumer’s state.
Consumers are required to remit use taxes to their taxing jurisdiction. Compliance
with this requirement, however, is quite low. Because of the low compliance, many
observers suggest that the expansion of the internet as a means of transacting
business across state lines, both from business to consumer (B to C) and from
business to business (B to B), threatens to diminish the ability of state and local
governments to collect sales and use taxes.
Congress has a role in this issue because commerce between parties in different
states conducted over the Internet falls under the Commerce Clause of the3
Constitution. Congress can either take an active or passive role in the “Internet tax”
debate. This report intends to clarify important issues in the Internet tax debate.
A Brief History of the Sales and Use Tax. In 1932, Mississippi was the
first state to impose a general state sales tax.4 During the remainder of the 1930s, an
era characterized by declining revenue from corporate and individual income taxes,

1 U.S. Bureau of the Census, “2004 State Government Tax Collections,” available online at
[ h t t p : / / www.census.go v/ go vs / www/ st at et ml ] .
2 U.S. Bureau of the Census, “State and Local Government Finances: 2001-02,” available
online at [].
3 U.S. Constitution, art. 1, sec. 8.
4 In Mississippi, a use tax, the companion to the sales tax, was added in 1938. A use tax is
a tax on the use of a product. In the early years of the sales tax, states began with general
sales then added the use tax. Eventually, states adopting a sales tax included the use tax in
the enacting legislation.

23 other states followed suit and implemented a general sales tax.5 At the time, the
sales tax was relatively easy to administer and could raise a significant amount of
revenue with a relatively low rate.6 Given the relative success of the sales tax in
raising revenue, 45 states and the District of Columbia added the sales tax to their tax
infrastructure by the late 1960s. The last of the 45 states to enact a general sales and
use tax was Vermont in 1969.7
What Are “Internet Taxes”? Over the last several years, a number of bills8
have been introduced in Congress that address “Internet taxes.” For this report, and
in the majority of the legislation introduced, “Internet taxes” refer to two sub-federal
taxes: (1) state sales taxes on Internet access services (sometimes referred to as
Internet access taxes) and (2) state sales and use taxes on products and services
purchased over the Internet. Internet access taxes, in states where they exist, are
typically a sales tax (or gross receipts tax, GRT) on Internet access services.9 The
Internet Tax Freedom Act (ITFA) defines Internet access service as a service “...that
enables users to access content, information, electronic mail, or other services offered10
over the Internet....” The economic burden of an Internet access tax is shared by
access providers (such as America Online and Earthlink) and consumers of Internet
The most recent extension of the Internet tax moratorium (P.L. 108-435)
prohibited Internet access taxes unless they existed before the original passage of the
ITFA in October 1998. The extension of the moratorium expires November 1, 2007.
A permanent prohibition of Internet access taxes would prevent state and local
governments from ever assessing a sales tax (or GRT) on the provision of these
services. Some observers have argued that the definition of Internet access should
be broadened to ensure that all means of connecting to the Internet — such as
through digital subscriber lines (DSL) — are treated equally.
The most recent moratorium extension modified the moratorium to include new
taxes on DSL (those not existing before November 1, 2003). Under the original

5 Fox, William F., ed., Sales Taxation: Critical Issues in Policy and Administration, Sales
Tax Trends and Issues, by Ebel, Robert and Christopher Zimmerman (Westport, CT:
Praeger, 1992), pp. 3-26.
6 The highest rate in 1934 was 3%, which was considered quite high at the time. Today, in
some Oklahoma jurisdictions, the rate can be as high as 9.75%.
7 The five states without a state sales and use tax are: Alaska, Delaware, Montana, New
Hampshire, and Oregon. Alaska allows local jurisdictions to impose a local sales tax.
8 For a review of Internet related legislation introduced in the 108th Congress, see CRS
Report RL33261, Internet Taxation: Issues and Legislation in the 109th Congress, Steven
Maguire, Nonna A. Noto.
9 A gross receipts tax, such as New Mexico’s, is a business tax that is levied on all of the
revenues generated by a business operating in the state. The grand-fathering provision in
the Internet Tax Freedom Act, allowed states with Internet access taxes in place to keep
them. The current list of states with Internet access taxes: New Mexico, North Dakota,
Ohio, South Dakota, Tennessee, Texas (with a $25 exemption), and Wisconsin.
10 P.L. 105-277, Title XI.

moratorium, telecommunications services, including DSL, were not subject to the
moratorium and thus were taxable (although cable Internet access was included in the
moratorium). Many states began taxing DSL services and during the debate over the
most recent extension (P.L. 108-435), many policymakers proposed including DSL
in the moratorium. As a compromise, Congress banned new DSL taxes and allowed
states that had already taxed DSL to continue to do so for the life of the
moratorium. 11
The second type of “Internet tax” is the imposition of the sales and use tax on
transactions arranged over the Internet. The expanding acceptance of the Internet as
an alternative to traditional retail transactions has complicated the collection of this
tax. Generally, if a vendor does not have “nexus” (loosely defined as a physical
presence) in the buyer’s home state, then the vendor is not required to collect the
sales or use tax. In these situations — where the vendor does not have nexus — the
buyer is required to remit a use tax to his or her state government typically through
the state income tax. In reality, consumer compliance with this requirement is quite
low. Thus, contrary to what some observers suggest, Internet purchases are “tax-
free” only in the sense that consumers are evading the use tax due on those
t ransact i ons. 12
The variation among the state and local governments in the administration of
the sales tax is at the center of the Internet tax debate. The U.S. Supreme Court has
ruled that the collection of sales taxes by remote vendors would be too burdensome;
there are thousands of taxing jurisdictions, each with its own rates and base.13 In an
effort to minimize that administrative burden, many states are working together to
simplify and standardize their tax systems in the hope that Congress will grant them
the authority to require remote vendors to collect the sales tax. This initiative is
identified as the Streamlined Sales and Use Tax Agreement (SSUTA).14
Simplification of sales and use taxes will be difficult because of the extensive
variation among states in the administration of the sales and use tax. An analysis of
state and local sales tax systems follows below.
Two Components of the Sales and Use Tax
The revenue that a sales and use tax generates, assuming a given level of
compliance, depends upon the chosen rate and the base to which the rate applies.

11 A special provision applying only to Wisconsin extends the grandfather provision for
existing DSL taxes in that state through November 1, 2005, not November 1, 2007.
12 Tax evasion is illegal, whereas tax avoidance, where individuals change their behavior to
reduce their tax burden, is legal. For example, moving to a state with no personal income
tax, such as Florida, Maine, or Texas, is legal state income tax avoidance. A Florida
resident not paying the Florida use tax on an out-of-state purchase is tax evasion.
13 Two decisions shape the current legal status of remote collection: National Bellas Hess,
Inc. v. Department of Revenue State of Illinois, 386 U.S. 753 (1967) and Quill Corporation
v. North Dakota, 504 U.S. 298 (1992).
14 See CRS Report RS22387, The Streamlined Sales and Use Tax Agreement: A Brief
Description, by Steven Maguire.

The more narrow the base the higher the rate must be to raise an equivalent amount
of revenue. States often have similar consumption items included in their tax base,
but they are far from uniform. Tax rates can also vary considerably, depending on
the state’s reliance on other revenue sources. The SSUTA is intended to create a
more uniform sales tax system among participating states.
The SSUTA would establish a system where states would use common
definitions for goods and services. Once a uniform definition is established, states
would then indicate whether the good or service is taxable. In addition, states would
also identify which entities would be exempt from paying sales taxes (e.g., non-profit
or religious organizations).
Tax Base. The sales tax, which is often considered a consumption tax, is
perhaps better identified as a transaction tax on tangible personal property;
expenditures on Internet access, legal, and medical services are often excluded from
the state sales tax base.15 In many states, groceries are also exempt from the sales tax
or taxed at a lower rate (see Table 1). A true consumption tax would include all
income that is not saved, including personal expenditures on services.16
Business-to-business transactions are often exempt from the retail sales tax,
particularly in cases where the purchaser is using the good as an input to production.
These transactions are exempt because including the transactions could lead to the
“pyramiding” of the sales tax. For example, if a coffee shop were to pay a retail sales
tax on the purchase of coffee, and then impose a retail sales tax on coffee brewed for
the final consumer, the total sales tax paid for the cup of coffee would likely exceed
the statutory rate. Products that a business purchases for resale are typically not
assessed a retail sales tax for a similar reason. If a coffee shop buys beans only for
resale, levying a sales tax on the wholesale purchase of the beans and then on the
retail sale would more than double the statutory rate. Tax treatment of business
purchases is not uniform across states. According to recent estimates, approximately

18% of business purchases are taxable, more or less, depending on the state.17

Many individuals and organizations are also exempt from state sales taxes.
Entities wishing to claim the sales tax exemption are often issued a certificate
indicating their tax-free status and are required to present this certification at the
point of transaction. Non-profit organizations, such as those whose mission is
religious, charitable, educational, or promoting public health, often hold sales tax-
exempt status.
Tax Rate. The second component of a sales tax is the tax rate applied to the
base described in the previous section. In 39 states, local governments piggy-back

15 For example, only two states tax medical services, Hawaii and New Mexico.
16 A common identity in the economics of income accounting is the following: C=Y-S. Or,
consumption (C) equals income (Y) less saving (S). Thus, income less savings is total
17 Cline, Robert, John Mikesell, Tom Neubig, and Andrew Philips, “Sales Taxation of
Business Inputs,” Council on State Taxation Special Report, January 25, 2005.

a local sales tax (which often varies among localities within the state) on the state
sales tax; 11 states and the District of Columbia levy a single rate (see Table 2) with
no local taxes. Some states in the group of 39 may collect a uniform local tax along
with the state tax and send the local revenue share back to the localities. This
structure would look like a single rate to the consumer because vendors typically do
not differentiate between the state and local share. For example, vendors in Virginia
levy a 5.0% sales tax on purchases and remit the entire amount to the state. The state
then sends what would have been raised by a 1% tax back to the local jurisdiction
where the tax was collected. The state of Virginia keeps the remaining 4.0%.
Generally, states with a broader base can collect the same amount of revenue at
a lower rate than a state with a narrow base. Mississippi, Rhode Island, and
Tennessee have the highest state sales tax rate of 7.0%. However, in 2006, Alabama
had the highest potential combined state and local rate of 12.0%. Residents in high
sales tax rate jurisdictions could gain from Internet purchases (and tax evasion) more
than those in low tax rate states. Recognizing this potential revenue drain, many
states have stepped up efforts to inform consumers of their responsibility to pay use
taxes on internet and mail-order catalog purchases.18 As suggested earlier, states with
high rates — and whose residents have a greater incentive to evade taxes — are
exposed to greater potential revenue losses from the growth of Internet commerce.
Because of the greater potential losses, these states are more likely to support reforms
that help maintain their sales and use tax revenue base.
Table 2 presents the sales tax rates for the 50 states, their localities, and the
District of Columbia. Also reported in Table 2 is the reliance (as measured by CRS)
of state and local governments on the general sales (or gross receipts) tax. Even
though gross receipts taxes have more in common with traditional business taxes, the19
Bureau of the Census combines them with general sales taxes. Depending on the
state law and the vendor, revenue generated by Internet transactions with out-of-state20
purchasers may or may not fall under the gross receipts tax.
Internet Taxes: Economic Issues
During the debate about “Internet taxes,” some economic issues will be
important to consider. How will the treatment of Internet taxes influence the
efficiency and equity of state tax systems? What will be the impact of changes in the
treatment of Internet transactions on states that are more reliant on the sales tax?

18 For example, see Chris Micheli, “California Strengthens Sales/Use Tax Collections,”
State Tax Notes, Dec. 15, 2003, pp. 964-965.
19 The Bureau of the Census also collects data on excise taxes and selective sales. We do
not report these receipts because they are typically collected at the wholesale level, not at
the point of retail transaction. For example, the gasoline excise tax is typically paid by the
carrier (tanker truck) at the point of collection (the end of the pipeline), not retail sale.
20 Under a gross receipts tax (GRT), a vendor remits a designated percentage (e.g., 5% in
New Mexico) of monthly gross receipts (or sales revenue) to the state. A gross receipts tax
is different from the sales tax because the vendor is legally responsible for paying the tax,
not the purchaser. Under the sales tax, the vendor acts as the collection agent for the taxing
jurisdiction and is not technically “paying” the tax; the buyer is paying the tax.

What will the potential revenue loss be absent changes in the treatment of Internet
transactions? A summary of those issues follows below.
Efficiency. A commonly held view among economists is that a “good” tax (or
more precisely, an efficient tax) is one that does not significantly distort consumer
behavior. Broadly speaking, individuals should make the same choices before and
after a tax is imposed. The greater the distortions in behavior caused by a tax, the
greater the economic welfare loss. A sales tax levied on all consumer expenditures
equally would satisfy this definition of efficiency. However, as noted earlier, under
the current state sales tax system, all consumption expenditures are not treated
equally. The growth of tax-free Internet transactions, both business to business and
business to consumer, will likely amplify the efficiency losses from altered consumer
An alternative theory for sales taxation is referred to as “optimal commodity
taxation.” Under an optimal commodity tax, the tax rate should be based on (or
determined by) the price elasticity of demand for the product (sometimes called the
“Ramsey Rule”). Conversely, products that are price inelastic, meaning quantity
demanded is insensitive to changes in price, should be levied a higher rate of tax.
Products that are price elastic, should have a lower rate of tax. If products purchased
over the Internet are relatively more price elastic, then the lower tax rate created by
effectively tax-free Internet transactions may improve economic efficiency.
However, the price elasticity of products available over the Internet is difficult to
measure and the efficiency gain, if any, would be small.21
An additional economic inefficiency would arise if vendors change location to
avoid collecting sales taxes. The location change would likely result in higher
transportation costs. In the long run, it is conceivable that the higher transportation
costs would erode the advantage of evading the sales tax.
For example, consider a Virginia consumer who wants to buy a set of
woodworking chisels.22 The local Virginia hardware store sells the set for $50
(including profit). An Internet savvy hardware store in Georgia is willing to sell the
same chisel set for $52 inclusive of profit and shipping costs. So, before taxes, the
local retailer could offer the chisels at a lower price. The marginal customer, who is
indifferent between the two retailers before taxes, is just as likely to buy from the23

Internet retailer as from the local retailer.
21 Equity has both horizontal and vertical components. A tax is defined as horizontally
equitable if people of equal circumstances pay equal taxes. A tax is defined as vertically
equitable if people with a greater ability to pay carry a greater tax burden than those less
able to pay. An optimal commodity tax would likely violate accepted principles of vertical
22 This example is based on one provided in Dennis Zimmerman, “The Internet Sales Tax
Debate: Sorting Through the Economic Issues,” paper prepared for the 94th Annual
Conference, National Tax Association, Baltimore, MD, Nov. 8-10, 2001.
23 The pre-tax absolute price difference between the two retailers is unimportant. The
Internet price inclusive of shipping could actually be lower before taxes. The application

However, the Virginia state and local sales tax of 5.0% yields a final sales price
to the consumer of $52.50. Given the higher relative price inclusive of the tax, the
marginal consumer, along with many other consumers, would likely switch to buying
chisels from the Georgia based Internet retailer (assuming these consumers do not
feel compelled to pay the required Virginia use tax on the Internet purchase). The
diversion from retail to the Internet in response to the non-collection of the use tax
represents a loss in economic efficiency. The additional $2 in production costs ($52
less $50) represents the efficiency loss to society from evading the use tax.24
Note that if in the absence of sales and use taxes, the Internet vendor in the
above example may yield to market forces and close up shop. However, if the
Internet vendor continues to operate even without the tax advantage, it could be the
case that consumers are willing to pay higher prices for the convenience of Internet
shopping. If this were true, then the higher “production costs” for Internet vendors
would not necessarily result in an efficiency loss.
Equity. The sales tax has often been criticized as a regressive tax, or a tax that
disproportionately burdens the poor.25 Assuming Internet shoppers are relatively
better off and do not remit use taxes as prescribed by state law, they can avoid paying
tax on a larger portion of their consumption expenditures than those without Internet26
access at home or work. Consumers without ready Internet access are not afforded
the same opportunity to “evade” the sales and use tax. In this way, electronic
commerce may actually exacerbate the regressiveness of the sales tax, at least in the
short run. As computers and access to the Internet become more readily available,
the potential inequity arising from this aspect of the “digital divide” could diminish.
Differential Effect Among States. The growth of Internet based commerce
will have the greatest effect on the states most reliant on the sales and use tax. In
addition to having more revenue at risk, high reliance states also face greater
efficiency losses because of their generally higher state tax rates. As noted earlier,
higher rates drive a larger wedge between the retail price inclusive of the sales tax
and the Internet price and thus exacerbate the efficiency loss from the sales tax.
States with low rates (and less reliance) would tend to have a smaller wedge between
the two modes of transaction. High rate-high reliance states would tend to recognize
the greatest revenue loss from a ban on the taxation of Internet transactions.

23 (...continued)
of the use tax makes the local retailer’s product relatively more expensive, regardless of
what the prices were before taxes.
24 Shipping costs can be thought of as a cost of production. The local retailer probably also
paid shipping costs to have the product on the shelf. Those costs are included in the price
of the good. Because the local retailer likely bought in bulk, the shipping cost per unit
would be considerably lower than the Internet retailer.
25 A regressive tax collects a smaller percentage of income as income increases. Economists
will usually avoid normative questions of what is equitable because such a statement implies
an interpersonal comparison of utility.
26 Goolsbee and Zittrain (1999) found that the average Internet user had on average two
more years of education and $22,000 more in family income than non-Internet users.

Based upon CRS calculations of state and local sales tax revenue as a portion
of total tax revenue, Washington, Tennessee, and Arizona, are the state and local
jurisdictions most reliant upon the sales and use tax.27 In those states, over 40% of
total tax revenue is derived from the sales tax. This result is not surprising:
Washington and Tennessee do not have comprehensive personal income taxes and
Arizona has a relatively high 11.6% combined sales tax rate. Ordinal rankings of
sales tax reliance appear in the last column of Table 2. Note that the seven states
without an income tax are all in the top 15 on the reliance index.28 The District of
Columbia would have been near the bottom of the reliance measure if it were a state.
The third column (c) of Table 2 reports the highest local sales tax rate for those states
that levy local sales taxes.
Revenue Loss Estimates. Economists Donald Bruce and William Fox
estimated in July 2004 that the “new e-commerce” loss in 2003 was approximately
$8 billion.29 “New e-commerce,” as measured by Bruce and Fox, is the lost revenue
from states not collecting the use tax on remote Internet transactions. This estimate
excludes purchases made over the telephone or through catalogs that would have
occurred anyway. An earlier General Accounting Office (GAO) report estimated that
the revenue loss in 2003 from internet sales would be between $1.0 billion and $12.430
billion. The wide range of the GAO estimate reflects the degree of uncertainty on
the size of the potential state and local revenue loss from e-commerce.
The rapid growth of electronic commerce is exhibited by data provided by the
U.S. Bureau of Census and could imply that the state and local revenue loss will
grow over time. According to retail survey data from the U.S. Department of
Commerce, “the third quarter 2004 e-commerce [sales] estimate [$17.6 billion]
increased 21.5% from the third quarter of 2003.”31
Policy Options
Congress can play an active or passive role in the remote vendor tax collection
debate. A more active role would likely involve new limits on the ability of state and
local governments to levy taxes on Internet access and to further regulate transactions
conducted over the Internet. A passive approach would end the moratorium, which

27 In addition, those three states were well above the average state tax rate in the U.S. of just
over 5.3% (of the 45 states with a state sales tax and the District of Columbia). The state tax
rates for those three states were: Washington, 6.5%; Florida, 6%; and Tennessee, 7%.
28 New Hampshire and Alaska are not included in the seven because neither has a state level
sales tax on which to rely
29 Donald Bruce and William F. Fox, “State and Local Sales Tax Revenue Losses from E-
Commerce: Estimates as of July 2004,” University of Tennessee Center for Business and
Economic Research, July 2004, p.5.
30 U.S. General Accounting Office, Sales Taxes: Electronic Commerce Growth Presents
Challenges; Revenue Losses Are Uncertain, GAO Report OCE-00-165 (Washington: June

30, 2000), p. 21.

31 U.S. Census Bureau, Monthly Retail Surveys Branch, November 19, 2004, available at
[ h t t p : / / www.census.go v/ mr t s / www/ dat a / pdf / 04Q3.pdf ] .

expires on November 1, 2007, and not introduce any additional legislation that
directly affects taxes on Internet commerce including the remote collection issue.
This section explores some possible outcomes and consequences of the two
Active Approach. The active options available to Congress range from (1)
forbidding sub-federal governments from levying taxes on both Internet access and
on transactions conducted over the Internet, regardless of nexus issues to, (2)
requiring remote vendors (those without nexus) to collect and remit use taxes. The
first option is unlikely without an accompanying concession by the federal
government to compensate for the federal mandate. The second option is unlikely
without continued action by the states and local governments to simplify and32
harmonize their tax regimes.
Both extremes in the active approach have their supporters. However,
proponents closely aligned with the first option, essentially creating an Internet tax-
free zone, seem driven more by reducing taxes generally than by other policy
concerns. Supporters closer to the other option are concerned about state revenue
losses as well as the apparent need to reform state and local taxes. These activists
believe the Internet tax debate provides a unique opportunity to simplify and reform
state and local sales taxes.
Passive Approach. This approach, not renewing the moratorium and
inaction on the use tax collection issue, would implicitly maintain the current
limitations on the states’ ability to require remote vendors to collect sales and use
taxes. Some observers believe that this course may result in states depending less on
the sales tax because untaxed Internet transactions would, over time, significantly
erode the revenue base. The lost sales tax revenue would likely be replaced by a tax
source that is potentially less stable (e.g., the individual income tax or corporate
income tax). Unstable revenue sources are unwelcome to state officials who must
balance their operating budgets annually (or biannually). And, unlike the federal
government, states face constitutional (or legislated) restrictions on the use of debt
and on the total amount of debt outstanding.33 Thus, funding temporary shortfalls
with borrowing is more difficult for state and local governments than for the federal
government. A move away from the sales tax as a primary revenue source could
present difficult fiscal choices for state and local governments.
Nevertheless, advocates of the passive approach suggest that a lower tax burden
on Internet transactions would help small Internet retailers compete with larger,
established retail entities. While a relatively lower tax burden would clearly help
Internet vendors in the short run, direct payments to Internet vendors would seem to
be a more transparent means of delivering a subsidy.
Opponents of congressional passivity on the sales and use tax collection issue
focus on potential state revenue losses if Congress does nothing. Also, the

32 Charles McLure Jr., “SSTP: Out of Great Swamp, But Whither? A Plea to Rationalize
the State Sales Tax,” State Tax Notes, December 31, 2001, p. 1077.
33 All states except Vermont have some type of balanced budget rule.

differential tax treatment of Internet vendors and traditional bricks and mortar
vendors is cited by opponents of congressional inactivity in the Internet tax debate.
Finally, some critics of the passive approach believe that anticipated congressional
action provides the impetus for state and local governments to simplify their sales tax
Table 1. State and Local General Sales and Gross Receipts
Taxes as Percent of Total Personal Income, by State, FY2002
GSGR State &GSGR Tax as
StateLocal Tax RevenueState PersonalPercent of
(italics =no statein FY2002Income 2002Personal Income
income tax)($000’s)($ millions)2002
(a) ( b) (c) ( d)
Alabama 2,968,306 112,737 2.63%
Alaska 121,944 20,699 0.59%
Arizo na 5,783,197 142,868 4.05%
Arka nsa s 2,540,788 63,720 3.99%
Ca lif o r nia 31,292,794 1,158,679 2.70%
Co lo ra do 4,127,711 149,958 2.75%
Co nnect icut 3,043,971 147,784 2.06%
Dela w a re 0 26,465 0.00%
Dist. of Columbia558,48024,0462.32%
Flo rid a 15,034,278 494,648 3.04%
Georgia 7,493,304 246,720 3.04%
Haw a ii 1,612,333 37,348 4.32%
Ida h o 796,373 33,605 2.37%
Illino i s 7,528,462 420,913 1.79%
India n a 3,798,490 173,932 2.18%
Io w a 2,016,193 83,051 2.43%
Kansas 2,294,733 79,144 2.90%
K e nt ucky 2,312,322 104,691 2.21%
Lo uisia n a 4,838,025 114,064 4.24%
Maine 836,134 35,913 2.33%
Maryland 2,690,434 198,119 1.36%
M a ssa c huse t t s 3,695,874 252,252 1.47%
M ichigan 7,784,308 304,490 2.56%
M i nneso t a 3,782,249 171,026 2.21%
M i ssissippi 2,341,447 64,248 3.64%
M i sso ur i 4,246,139 164,143 2.59%
Montana 0 22,755 0.00%

GSGR State &GSGR Tax as
StateLocal Tax RevenueState PersonalPercent of
(italics =no statein FY2002Income 2002Personal Income
income tax)($000’s)($ millions)2002
(a) ( b) (c) ( d)
Nebraska 1,287,48751,4802.50%
Nevada 2,216,779 65,596 3.38%
New Hampshire*043,7780.00%
New Jersey5,996,839338,9121.77%
New Mexico1,764,87944,4123.97%
New York16,630,208690,4882.41%
North Carolina4,909,217230,5562.13%
North Dakota394,50817,1092.31%
Ohio 7,686,517 335,841 2.29%
Okla ho ma 2,600,204 89,350 2.91%
Oregon 0 101,176 0.00%
Pennsylvania 7,500,034 391,354 1.92%
Rhode Island731,59733,5032.18%
South Carolina2,435,404104,3202.33%
South Dakota671,95220,4683.28%
T e nnessee * 5,841,589 160,414 3.64%
Texas 18,321,523 621,832 2.95%
Uta h 1,970,374 56,299 3.50%
Vermont 214,746 18,231 1.18%
Virg inia 3,586,938 240,115 1.49%
Washington 9,231,321 198,317 4.65%
West Virginia962,75642,6822.26%
Wisc o n sin 3,913,811 162,818 2.40%
Wyom ing 579,715 15,249 3.80%
Sources: Columns (b) and (c), U.S. Bureau of Census; column (d), author’s calculations.
Notes: *Only capital income included in the personal income tax in NH and TN.

Table 2. State and Local Reliance on the Sales and Gross
Receipts Tax, by State, FY2002
Total StateGSGR
Top& LocalState &GSGR Tax
LocalTaxLocal Taxas % of
StateRateRevenue inRevenueFY2002State
Rate ininFY2002in FY2002TaxReliance
St a t e 2005 2005 ($000’s) ($000’s) Rev e nue Ra nk
(a) ( b) (c) ( d) (e) ( f) (g)
Alabama 4.000 8.000 9,718,827 2,968,306 30.5% 16
Ala ska n/a 7 .000 2,069,908 121,944 5.9% 47
Arizo na 5.600 4.500 14,420,322 5,783,197 40.1% 3
Arka nsa s 6.000 5.500 6,460,855 2,540,788 39.3% 5
Ca lif o r nia 6.250 2.500 120,424,066 31,292,794 26.0% 21
Co lo ra do 2.900 7.000 13,900,024 4,127,711 29.7% 17
Connecticut *6.000n/a15,124,9283,043,97120.1%36
Dela w a re n/a n/a 2,687,098 0 0 .0% 5 0
Dist. of Columbia5.750n/a3,227,909558,48017.3%42
Florida 6.000 1.500 44,840,449 15,034,278 33.5% 11
Georgia 4.000 3.000 24,058,380 7,493,304 31.1% 14
Hawaii *4.000n/a4,239,5571,612,33338.0%6
Ida h o 5.000 3.000 3,291,095 796,373 24.2% 26
Illino i s 6.250 3.000 41,569,580 7,528,462 18.1% 40
Indiana *6.000n/a16,986,6373,798,49022.4%28
Io w a 5.000 2.000 8,330,414 2,016,193 24.2% 25
Kansas 5.300 3.000 7,974,975 2,294,733 28.8% 19
Kentucky *6.000n/a10,780,7572,312,32221.4%30
Lo uisia n a 4.000 6.750 12,182,065 4,838,025 39.7% 4
Maine *5.000n/a4,541,146836,13418.4%39
Maryland *5.000n/a19,874,2812,690,43413.5%45
Massachusetts *5.000n/a23,895,4363,695,87415.5%44
Michigan *6.000n/a30,644,1847,784,30825.4%22
M i nneso t a 6.500 1.000 18,456,409 3,782,249 20.5% 34
M i ssissippi 7.000 0.250 6,523,722 2,341,447 35.9% 9
M i sso ur i 4.225 4.125 15,123,432 4,246,139 28.1% 20
Montana n/a n/a 2,135,182 0 0 .0% 5 0
Nebraska5.5001.5005,316,341 1,287,48724.2%24
Nevada 6.500 1.000 6,432,564 2,216,779 34.5% 10

Total StateGSGR
Top& LocalState &GSGR Tax
LocalTaxLocal Taxas % of
StateRateRevenue inRevenueFY2002State
Rate ininFY2002in FY2002TaxReliance
St a t e 2005 2005 ($000’s) ($000’s) Rev e nue Ra nk
(a) ( b) (c) ( d) (e) ( f) (g)
New Hampshiren/an/a3,598,86200.0%50
New Jersey *6.000n/a34,628,8045,996,83917.3%41
New Mexico5.0002.8134,877,6141,764,87936.2%8
New York4.0004.50088,878,11216,630,20818.7%38
North Carolina4.5003.00022,576,4194,909,21721.7%29
North Dakota5.0002.5001,728,755394,50822.8%27
Ohio 5.500 2.000 36,165,190 7,686,517 21.3% 31
Okla ho ma 4.500 6.000 8,781,889 2,600,204 29.6% 18
Oregon n/a n/a 9,003,237 0 0 .0% 5 0
Pennsylvania 6.000 1.000 37,626,620 7,500,034 19.9% 37
Rhode Island *7.000n/a3,622,244731,59720.2%35
South Carolina5.0002.0009,751,7012,435,40425.0%23
South Dakota4.0002.0001,841,448671,95236.5%7
Tennessee 7.000 2.750 12,973,768 5,841,589 45.0% 2
Te xa s 6.250 2.000 58,980,508 18,321,523 31.1% 15
Uta h 4.750 3.250 6,026,142 1,970,374 32.7% 12
Vermont 6.000 1.000 1,965,132 214,746 10.9% 46
Virg inia 4.000 1.000 22,131,246 3,586,938 16.2% 43
Wa shington 6.500 2.400 19,513,503 9,231,321 47.3% 1
West Virginia *6.000n/a4,641,349962,75620.7%33
Wisc o n sin 5.000 1.000 18,609,916 3,913,811 21.0% 32
Wyoming 4.000 2.000 1,818,368 579,715 31.9% 13
Sources: State and local sales tax rate data in Columns (b) and (c) are from the: Sales Tax Institute,
[]. Columns (d) and (e): U.S. Bureau of
Census. Column (f) and (g): author’s calculations.
Notes: * Identifies the 11 states that do not have a local sales tax