For state and local governments, evolution of the digital economy is a double-edged sword. Against the backdrop of promised economic growth and efficiencies, electronic commerce and the Internet constitute a formidable threat to these taxing authorities' ability to assess and collect the retail sales tax. Under the Supreme Court's present interpretation of the Commerce Clause, states and localities are precluded from asserting taxing authority over firms who do not have a tangible, physical presence, or nexus, within their jurisdiction. This long-standing rule of law, which was established to protect mail-order transactions, might soon be coupled with proposed federal legislation designed to curtail further nexus as it exists on the Internet and electronic commerce transactions. If widely accepted projections concerning electronic commerce are correct, then this confluence of legal restrictions, states and localities argue, portends significant lost revenues.
This report examines this claim and rejects it. Though someday the digital economy may, in fact, impose such a burden on state and local budgets, the majority of electronic commerce and the Internet activity is intermediate, not retail and, therefore, not subject to sales tax. As such, the revenues that states and localities stand to lose at the hands of the digital commerce are negligible and are outweighed by the public policy interest of developing the Internet and electronic commerce.