The Sales Tax Chicken Game

Effective June 29, Amazon has cancelled its contracts with about 10,000 California-based affiliates after Govenor Brown signed a law that requires large out-of-state retailers with affiliates in California to collect sales tax on purchases made by their California customers.

California is the latest state to pass a law to push back against the exemption that allows out of state retailers to not collect sales tax - an exemption made by the US Supreme Court decades ago, in favor of the mail-order industry, based on the constitutional premise that one state may not tax another.

New York, Connecticut, Maryland, Hawaii, Missouri, Rhode Island, North Carolina and Minnesota have already passed similar laws and Amazon's response in each case has been to drop all affiliates in the state so as not to have to collect sales tax - except in New York where it has started to collect sales tax while challenging the law in court.

Proponents of the new law say that state and local governments in California are losing an estimated $1.1 billion in annual revenues because of untaxed internet sales.

Opponents of these "nexus laws" say that far from raising income, the states that have passed laws are actually losing money as the likes of Amazon just shuck off their affiliates and continue to not collect sales tax. Meanwhile, the in-state affiliates who have been unceremoniously dropped have to choose between loss of income or, in some cases where a business is highly reliant on affiliate income, going out of business or moving out of state.

Of course, just because an online retailer doesn't collect sales tax doesn't mean the tax doesn't have to be paid - it simply moves the onus of payment from the retailer to the consumer who should declare unpaid sales tax on his or her state tax return - but, let's face it, how many of us actually keep every online and mail order receipts for the year so we can calculate how much unpaid tax we need to declare on our return?

Speaking personally, and also as the owner of BookBrowse, which earns a very modest affiliate income from Amazon, I'm in favor of a level playing field when it comes to the collection of sales tax as it seems unfair that local stores must charge sales tax when internet retailers don't and, of course, a local store owned and operated by people living in the community returns far more of its earnings back into the local community than an internet business, so a level playing field should, in principle, be good for local enonomies as well.

But, of course, things are never quite as simple in practice. While the face of the sales tax movement has been independent stores, most notably independent bookstores, most of the funding for lobbyists comes from big box retailers such as Walmart who have much to gain from an internet sales tax as they, with a physical presence across the country, have to collect sales tax on all purchases, both internet and local, which puts them at a disadvantage versus Amazon and others who have no physical stores at all.

Also, while it is the big online retailers such as Amazon who have squealed the loudest at the prospect of collecting sales tax, and spend big bucks lobbying the federal government on the issue (Amazon spent $630,000 lobby the federal government in the first quarter of 2011), practically speaking it wouldn't be much of a problem for a large online retailer to adjust their systems to comply. However, the logistical nightmare for smaller "mom and pop" online retailers of having to calculate and remit sales tax to multiple different states really could be a deal breaker.

At the moment, it seems to me that individual states are in an elaborate and costly game of chicken with online retailers, with the affiliates stuck in the middle. I suspect that many state legislators behind these laws know that passing them will bring in only a fraction of the "lost" tax revenue in the immediate term but perhaps they are looking at the long game and the prospect that, if enough states pass such laws, then the federal government will have to step in and review the decision that exempts out of state companies from collecting sales tax - a decision which was made many moons ago when mail order sales would have been a tiny fraction of what internet sales are today.

The federal government is in a position to pass legislation on this issue as the Constitution gives it the right to tax interstate commerce. Of course, a whole other barrel of worms gets opened if the federal government does legislate to enforce the collection of sales tax by online retailers, not least because of the burden that could be placed on small companies struggling to collect and pay 50 different state taxes, and even large companies would likely flounder if they had to calculate every regional tax as well.

"The Main Street Fairness Act", a bill "to promote simplification and fairness in the administration and collection of sales and use taxes, and for other purposes", was introduced to the U.S. Congress last July, but it didn't get past committee. As I understand it, it's likely to be reintroduced this Fall in a bi-partisan effort with, I think, 20 states theoretically in support at this point. If this law is passed it will undoubtedly change the face of e-commerce, but will need some careful thinking through if it is to be workable for companies large and small.

One option that I've heard suggested is that all online sales would be levied at a fixed rate of tax making it easier to collect and remit, and that smaller companies would have the option of sending their sales tax revenues to a centralized agency that would distribute them (or perhaps this would be something that payment processors such as Paypal would take on). This would make the process much easier for companies than trying to calculate taxes by region, but, arguably, could end up putting online retailers at a disadvantage when selling to states with low or no sales tax, plus it introduces an administrative step in the process that has to be paid for by someone.

I don't know how this sales tax issue will play out over the next few years but one thing seems clear, the current system isn't working and affiliates and local businesses are getting the short end of the stick!

What do you think?

Davina, BookBrowse editor


Update July 12, 2011: Amazon says it will ask California voters to overturn a state law requiring all large companies with operations or affiliates in the state to collect sales tax. It is hoping to seek a referendum vote as early as February, which is more than likely to trigger an expensive political battle pitting Amazon (and possibly other large exclusively online retailers) against a much larger coalition of brick-and-mortar retailers such as Wal-Mart, Best Buy. and Target.