University of Tennessee, Knoxville TRACE: Tennessee Research and Creative Exchange Doctoral Dissertations Graduate School 8-2007 Internet Usage and State Sales Tax Competition Mary E. Howard University of Tennessee - Knoxville Follow this and additional works at: https://trace.tennessee.edu/utk_graddiss Part of the Business Administration, Management, and Operations Commons Recommended Citation Howard, Mary E., "Internet Usage and State Sales Tax Competition. " PhD diss., University of Tennessee, 2007. https://trace.tennessee.edu/utk_graddiss/194 This Dissertation is brought to you for free and open access by the Graduate School at TRACE: Tennessee Research and Creative Exchange. It has been accepted for inclusion in Doctoral Dissertations by an authorized administrator of TRACE: Tennessee Research and Creative Exchange. For more information, please contact [email protected]. To the Graduate Council: I am submitting herewith a dissertation written by Mary E. Howard entitled "Internet Usage and State Sales Tax Competition." I have examined the final electronic copy of this dissertation for form and content and recommend that it be accepted in partial fulfillment of the equirr ements for the degree of Doctor of Philosophy, with a major in Business Administration. LeAnn Luna, Major Professor We have read this dissertation and recommend its acceptance: Kenneth E. Anderson, Donald J. Bruce, William F. Fox Accepted for the Council: Carolyn R. Hodges Vice Provost and Dean of the Graduate School (Original signatures are on file with official studentecor r ds.) To the Graduate Council: I am submitting herewith a dissertation written by Mary E. Howard entitled “Internet Usage and State Sales Tax Competition.” I have examined the final electronic copy of this dissertation for form and content and recommend that it be accepted in partial fulfillment of the requirements for the degree of Doctor of Philosophy, with a major in Business Administration. LeAnn Luna________________ LeAnn Luna, Major Professor We have read this dissertation and recommend its acceptance: Kenneth E. Anderson____________ Donald J. Bruce________________ William F. Fox_________________ Accepted for the Council: Carolyn Hodges_____________ _ Vice Provost and Dean of the Graduate School (Original signatures are on file with official student records.) Internet Usage and State Sales Tax Competition A Dissertation Presented for the Doctor of Philosophy Degree The University of Tennessee, Knoxville Mary E. Howard August 2007 Dedication This dissertation is dedicated to my parents, Bobby and Sarah Palmer, for always believing in me, inspiring me, and encouraging me to achieve my goals and to my husband, Jonathan Howard, for always believing in, encouraging, and supporting me. ii Acknowledgements I would especially like to thank my committee members, LeAnn Luna (Chair), Ken Anderson, Don Bruce, and Bill Fox for their help and guidance in this process. In addition, I would like to thank Carl Hollingsworth and Brian Carver for their helpful research suggestions. I would also like to thank Brian Hill, Zach Richards, Bryan Shone, Martin Tackie, Laura Ullrich, and Terry Woodall for their support during my time in the Center for Business and Economic Research. This paper has benefited from the comments of workshop participants at Appalachian State University, Auburn University, Middle Tennessee State University, and Northern Kentucky University. iii Abstract This paper examines the influence of increasing access to the Internet and increasing online purchasing on sales tax competition among the states. Prior research indicates that the tax rates set by a state’s geographical neighbors influence the tax rate set by the home state. As consumers gain access to the Internet and begin to participate in online shopping, their opportunity cost to participate in cross-border shopping decreases and their “mobility” may increase due to the ease of purchasing from vendors lacking nexus in the consumer’s home state. Thus, states may begin to respond less to the sales tax changes of their geographic neighbors and may begin to define competitors differently. I find that increases in both the percentage of the population having Internet access and the percentage of the population making online purchases influence the response of a state to its neighbors’ tax rates. Specifically, states with higher percentages of either of these measures have more positive response functions when examining the “effective Internet tax rate” definition of neighbor. States appear to respond only slightly to changes in the tax rates of their geographic neighbors. This paper also examines the influence of Internet usage on the sales tax revenues of the states by separating the influences of cross-border shopping through traditional means and through the Internet. Research finds that consumers who live near physical borders are more responsive to tax differences than are consumers who live farther from physical borders. As more consumers access the Internet and begin to purchase goods online, all consumers may become as responsive to tax differences as are those who live near physical borders. Thus, both traditional means of cross-border shopping and cross-border shopping through use of the Internet would be expected to influence the sales tax revenues of a state. Surprisingly, I find that sales tax revenue per capita appears to increase with an increase in my measure of Internet-based cross-border shopping. This may indicate that online shopping does not act entirely as a substitute for local forms of shopping but rather represents an increase in consumption. iv Table of Contents 1. Introduction..................................................................................................................... 1 2. Theory and Prior Research.............................................................................................. 7 Cross-Border Shopping and Sales Tax Competition ...................................................... 7 E-Commerce and Sales Taxes ...................................................................................... 12 Hypotheses.................................................................................................................... 16 3. Research Method .......................................................................................................... 20 Sample Selection and Data Sources.............................................................................. 20 Method .......................................................................................................................... 21 Defining Neighbors................................................................................................... 21 Model ........................................................................................................................ 25 Competition Model 1 ............................................................................................ 25 Competition Model 2 ............................................................................................ 27 Revenue Model ..................................................................................................... 33 4. Results........................................................................................................................... 40 Descriptive Statistics..................................................................................................... 40 Tax Competition Model – Internet Access ................................................................... 41 Internet Neighbor...................................................................................................... 42 Geographic Neighbors .............................................................................................. 47 Tax Competition Model - Internet Purchases ............................................................... 52 Internet Neighbor...................................................................................................... 52 Geographic Neighbors .............................................................................................. 56 Sales Tax Revenue Model ............................................................................................ 60 5. Additional Analyses...................................................................................................... 64 Tax Competition Model - Internet Access.................................................................... 65 Most Recent Six Years.............................................................................................. 65 2003 and 2004 Only.................................................................................................. 66 Pew Internet Data...................................................................................................... 67 Separate Nexus and Lagged Tax Rate ...................................................................... 68 Tax Competition Model - Internet Purchases ............................................................... 69 Most Recent Six Years.............................................................................................. 69 2003 and 2004 Only.................................................................................................. 71 Separate Nexus and Lagged Tax Rate ...................................................................... 71 Sales Tax Revenue Model ...........................................................................................