About the time of Governor Leavitt’s inauguration, internet was becoming a unbiquitous presence in the lives of Americans. The growth of electronic commerce was anticipated to eclipse the growth of normal “bricks and mortar” retail activity. Noted economists and like Lester Thurow and Austin Goolsbe were predicting that half the store-fronts on main street would be vacant by 2010. Many people thought the convenience, selection, and economies of scale available to electronic retailers would drive traditional retailers out of business.
That eventuality would have profound impact on state and local tax revenues. Utah has a fairly balanced tax system in many ways. It has a property tax, which is a tax on wealth. That tax is imposed on wealth. It is assessed by County Assessors and collected by County Treasurers. The taxpayer receives a bill each year for his or her tax, without any effort on the taxpayer’s part. The state has an income tax, which is a tax on income. Although much of the tax is collected by employers through wage withholding, the income tax is essentially “self-assessed.” Each taxpayer files his or her own tax return every year, declaring income and computing the tax due. The state also has a sales tax, which is a tax on consumption. That tax is computed and collected largely by retail businesses in Utah, who collect six or seven cents on every dollar of taxable sales they make within the state.
If the retailers are out-of-state retailers, Quill says they don’t have to collect Utah sales tax on sales to Utah customers. This has profound implications for Utah’s tax base. It is true that there is a compensating use tax in Utah; that is, if a seller fails or is not required to collect the sales tax on a taxable sale, the owner of the property is nevertheless subject to a compensating use tax. The state is quite successful in collecting that tax from large, sophisticated businesses. They understand their obligations, there is wide audit coverage, and they accrue and pay their own use tax on a regular basis.
The situation is quite different, however, for individual citizens’ purchases for personal consumption. Of course, there are a few thousand knowledgeable and honest taxpayers who do accrue and report use tax on their individual income tax returns. In 2000, for example, about 4,000 individual returns reported about $205,000 in use tax. The next year, about 5,500 returns reported a total of almost $250,000 in use tax.
Most individuals, however, do not understand or comply with their obligations. The returns reporting use tax comprise less than ½ of 1% of all individual returns filed. And, because the number of taxpayers is large and the amount of tax that would be due from any individual taxpayer is small, there has been little audit coverage in the area. Indeed, given the numbers, an intensive audit effort would only be cost-effective if it had an in terrorem effect on the rest of Utah’s citizens.4 Moreover, income tax audits, which focus primarily on income and deductions that a taxpayer voluntarily chooses to claim are intrusive enough. A use tax audit that focused entirely on personal consumption would be viewed by many as a significant and unwarranted invasion of privacy.
Under those circumstances, a migration of a significant portion of Utah retail sales from local retailers who collect the Utah sales tax to internet retailers who do not collect the tax would have a potentially devastating effect on Utah’s budget. We have briefly described Utah’s tax structure above. The income taxes are constitutionally dedicated to education. The property taxes are dedicated primarily to local governments and the school fund. Gasoline taxes are dedicated to highway and road funding. The sales tax provides virtually of all the state source revenue that goes to the general fund.
There is also a multiplier effect at work. Internet retailers may or may not be able to compete effectively with local retailers based on their business models. But if customers perceive they can save 6 or 7% of the purchase price by avoiding sales tax, the competitive advantage is even greater. There is simply not a level playing field between bricks and mortar and internet retailers. This competitive disadvantage drives more customers to the internet and reduces sales tax revenues even more. As local retailers go out of business, they stop generating income and stop paying property taxes, and those resources decline as well.