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Home My WebLink About2000-06-10 City CouncilTO: City of Palo Alto City Manager’s Report HONORABLE CITY COUNCIL FROM:CITY MANAGER DEPARTMENT: CITY MANAGER’S OFFICE DATE:July 10, 2000 CMR: 268:00 SUBJECT: INTERNET/ECOMMERCE UPDATE This is an information report and no Council action is required. The purpose of this report is to identify Internet and electronic commerce (eCommerce) issues that have the potential to impact local revenues; discuss the impact in Palo Alto; and communicate strategies for keeping apprised of changes in this fast-paced economy. BACKGROUND The Internet and eCommerce have become the foundation of the "New Economy" in the Silicon Valley and throughout the world, eCommerce can be described as sales of goods and services over the Internet or other online system. Payment may or may not be made online. New figures released by the U.S. Census Bureau of the Department of Commerce estimate that, in fourth quarter 1999, overall retail sales were approximately $821.2 billion. Of this total, eCommerce sales represent 0.64 percent of total retail sales or $5.3 billion. Cities have become increasingly concerned about what impact eCommerce will have on "mainstreet" businesses that compete with eCommerce retailers, as well as the impact on local sales and use tax revenues. Sales and use taxes accrue to cities in three main ways: ¯ Businesses collect Sales tax from consumers~ a portion of the taxes collected is then allocated to the city where the point of sale is located. ¯Businesses collect sales tax from other businesses purchasing goods; it is then remitted to cities in the same manner as above. ¯Use tax is paid on the purchase of equipment from. out-of-state vendors. The State Board of Equalization (SBOE) is responsible for collecting sales and CMR:268:00 Page 1 of 4 use tax and enforcing policies related to the collection of these taxes, including sales transactions conducted over the Internet. When a business sells a product, the SBOE determines if the firm has nexus (or a physical presence) in the state where the sale originates. If it does, the consumer in that state pays the sales tax. If the product is sold by a business that does not have nexus in the state where purchased, no sales tax is paid. Although the purchaser in an out-of-state sales transaction is obligated to pay sales tax, very few individuals are aware of this requirement and even fewer comply. Products that are. digitized (can be downloaded or electronically delivered), are exempted by the SBOE from taxation. DISCUSSION. The current sales tax system at best is flawed. Some argue a total overhaul of the sales tax system is needed, because service businesses (which don’t collect sales tax) are not paying their "fair share" for local infrastructure and services. Others argue that the sales and use tax base must be protected to ensure continued delivery of local services. Some of the solutions rest with states, others withthe federal government. There is agreement, however, that legislation that ensures tax fairness and considers its potential impact to state and local government tax bases should be encouraged and supported by local government. The City’s sales tax accounts for 19 to 21 percent of General Fund revenues. City sales tax revenue is driven by several strong economic sectors: auto sales, restaurants and office equipment sales. While neighboring cities such as Mountain View and Sunnyvale have recently experienced losses of sales tax revenues that are attributed to digitized sales over the Internet, Palo Alto has not experienced these losses, partly because of the diversity of the City’s sales tax base. In addition, impact on Palo Alto is minimized since the City is not experiencing the same demographic shift from manufacturing to software as neighboring cities. Palo Alto’s sales tax has increased approximately I3 percent in the past three years. Attachment A provides information by economic sector on recent growth in sales tax. While sales tax performance continues to be strong in Palo Alto, there are significant issues to be considered. The first issue is the impact of electronic sales on local business viability. If local businesses are compelled to collect the 8.25 percent .sales tax on purchases and Internet sales are not taxed, there is a competitive disadvantage for local businesses compared to purchases made online. Coupled with the high cost of rents and low commercial and retail vacancy rates within Palo Alto, this competitive disadvantage becomes even more significant. "At risk" vendors, including those that sell books, compact discs and tapes, photographic equipment and electronic equipment/media, are especially vulnerable to Intemet sales. In business districts throughout the City, businesses that sell these goods-are often the businesses that add the most character to neighborhood shopping areas. Retailers ¯ such as Bell’s Books and Printer’s Inc. could be affected by online sales. CMR:268:00 Page 2 of 4 A second issue is how online sales will affect local revenues. Without adequate sales and use tax revenue, City services such as fire and police protection and road maintenance could be significantly impacted. The City’s sales tax consultant, MBIA MuniServices Company (MBIA), estimates that Palo Alto may forfeit as much as $2 million in sales and use taxes by the year 2002. In an effort to stay attuned to changes in the local economy, that might impact economic vitality in Palo Alto, City staff has identified several strategies. These include: ¯Participation in local and regional organizations, such as the Joint Venture Silicon Valley Tax and Fiscal Policy Subcommittee on the Internet, that are taking leadership in assessinglthe impacts of the Intemet, and monitoring legislation that can have a affect on City revenues and businesses, specifically staff. ¯ . Development of information, statistics and economic trends data for use by city departments and businesses for use in decision making. Sales tax, property tax and hotel vacancy rate information is evaluated regularly. ¯Determination of the need for a City policy position on eCommerce and the Internet. ¯Linking businesses to local, regional and state resources for technical assistance to assist them in competing in the global electronic marketplace. ¯Development of a citywide, targeted retail strategy to identify strengths, weaknesses, opportunities and threats, in order to chart a path for retail development in the future. While losses to the City at this point are relatively small relative to the overall sales tax base, they could grow significantly in the future and materially erode thebase. New developments will be closely monitored by City staff to determine the most effective role for the City to play in supporting or opposing legislation, providing assistance to local businesses and assessing impacts to the City’s financial viability. PREPARED BY:Emily Harrison, Assistant City Manager Susan Arpan, Manager, Economic Resources Planning Audrey Seymour, Senior Executive Assistant CITY MANAGER APPROVAL: ~. ~_~~) Emily ~arrison, Assistant City Manager ATTACHMENTS Attachment A:Cit~ of Palo Alto Generated Sales Tax Data Year-to-Date 4th Quarter 1999 Compared to Year-to-Date 4th Quarter 1999 CIVIR:268:00 Page 3 of 4 ATTACHMENT A City of Palo Alto Generated Sales Tax Data - Year to Date 4th Quarter 1999 Compared to Year to Date 4th Quarter 1998 Year-Ending Percent Of 1999 Year-Ending Percent of 1999 Dollar Change 4th Quarter Sales Tax 4th Quarter Sales Tax from 1998 to 1999 Revenues 1998 Revenues 1999 Percent Change from 1998 to 1999ECONOMIC SEGMENT DEPARTMENT STORES 2,863,543 15.3 2 758 758 16.3 104,785 3.8% AUTO SALES - NEW 2,417,287 12.9 2,124,142 12.6 293,145 13.8% RESTAURANTS 2,267,006 12.1 2,082,420 12.3 184,586 8.9% MISCELLANEOUS RETAIL 2,078,457 11.1 1,899,796 11.2 178,661 9.4% FURNITURE/APPLIANCE 1,364,784 7.3 1,148,427 6.8 .216,357 18.8% OFFICE EQUIPMENT 1,305,781 7 886,862 5.2 418,919 47.2% APPAREL STORES 1,145,170 6.1 1,032,408 6.1 112,762 10.9% BUSINESS SERVICES 1,004,525 5.4 993,594 5.9 10,931 1.1% ELECTRONIC EQUIPMENT 992,223 5.3 904,841 5.3 87,382 9.7% LIG HT INDUSTRY 595,271 3.2 726,606 4.3 -131,335 -18.1% FOOD MARKETS 350,160 1.9 346,449 2.0 3,711 1.1% RECRE.ATION PRODUCTS 334,611 1.8 314,136 1.9 20,475 6.5% LEASING 318,272 1.7 245,749 1.5 72,523 29.5% SERVICE STATIONS 303,077 1.6 274,765 1.6 28,312 10.3%CHEMICAL PRODUCTS 238,233 1.3 175,957 1.0 62,276 35.4% OTHERS 1,159,136 6.0 861,872 6.0 297,264 34.5% 18,737,536 100 16,913,133 100 1,824,403 10.8%Total Sales Tax CMR:268:00 Page 4 of 4