Analyst Warns of Tax Loss from Net Sales

The explosion in untaxed Internet sales may be costing California as much as $200 million a year in lost sales tax revenue, a state budget analyst said Monday.

Legislative analyst Elizabeth Hill said the problem isn’t serious now but could be in a few years as more shoppers rely on e-commerce to make purchases.

Estimates of the current annual revenue loss range from the high tens of millions of dollars to $200 million, she said.

By 2003, the loss could reach the high hundreds of millions of dollars--as much as 4% of sales taxes.

“This evolution of the Internet raises some basic fairness and equity issues and also the issue of the erosion of the tax base,” she said.

California’s sales tax, which ranges from 7.25% to 8.5% depending on the county, is the state’s second biggest revenue source. It is expected to generate $32.1 billion this fiscal year.

It could become a less reliable source of revenue as Internet use increases, Hill said in a report to lawmakers.

Connie Squires, chief of financial research for the state Department of Finance, said administration officials “share the concern to the extent that it’s definitely something that needs to be watched.”

She said a portion of the estimated tax loss may not be a loss at all but the result of consumers shifting from buying nontaxable items through catalogs to buying on the Internet.

“It’s all speculative at this point as to what extent this is going to take off,” she said. “But there certainly seems to be the potential for it.”

E-commerce now makes up about 1% to 2% of retail sales worldwide. That figure is expected to jump to 15% by 2003.

Currently, the state is able to tax Internet sales to Californians only if the seller has a physical presence--a store or some other facility--in the state, Hill said.

Mark Ibex, a senior analyst with Hill’s office, said it would take federal legislation to expand the state’s taxing power because the U.S. Supreme Court has ruled that an Internet business must have a presence in a state to be taxed.

Use of the Internet for sales can also transform certain taxable items such as books into nontaxable merchandise by transferring them to the buyer digitally, Hill said.

Hill recommended that California consider signing agreements with the other 44 states that levy sales taxes to make it easier to collect on Internet transactions.

To simplify things, the states might want to agree on a single nationwide rate and ask the federal government to collect it, Hill said. But that agreement may not be easy to reach, she added.