The Amazon Tax

In these cash-strapped times legislators everywhere are trying to find creative ways to raise revenue. California, for example, is issuing IOUs to help temporarily ease its cash crunch. Lawmakers in both Rhode Island and North Carolina are trying another tactic: they are trying to tax the internet.

Before we pass judgement, however, a little background is in order. Way back in the mid 1990's, when the nascent internet was just developing "ecommerce" in earnest, Congress decided it was best not to tax the internet so as not to nip in the bud the growth engine that ecommerce was deemed to be. State legislatures were and still are very worried about lost sales tax revenue. If a company has no physical presence in your state, the state can not collect sales taxes from it. So when Amazon ships a book from Washington to Colorado, Colorado can not collect sales tax because Amazon has no presence in CO. Washington does not tax Amazon's sales (unless in WA) because the shipment to CO is inter-state commerce, protected from tax by the Constitution.

The more sales that go online across state-borders, the more sales tax revenue is lost. The effect has not been hugely significant as the economy and sales grew across the board while ecommerce is still a relatively small slice of the pie. Now that the economy is faltering and state revenues are being pinched, legislatures are reviving ideas of how to claim a physical presence of online retailers in order to collect sales taxes.

How can a state tax a retailer with no physical presence in-state? Way back in 2008, New York passed a law that required online retailers to collect sales tax if they have affliates in the state. "Affiliates" are marketing arrangements where someone posts a link to a product and receives a sales commission when someone buys it through their link. If a New Yorker, say "Paul", lives in Manhatten and refers people to Amazon to buy his book as an affiliate, Amazon has enough physical presence in the state (according to the law) that it must collect sales tax for all purchases in NY.

Naturally, Amazon challenged this "Amazon Tax" in court, arguing the affiliates were not employees and that Amazon still has no physical presence. Not long after, the case was rejected by the New York Supreme Court, handing Amazon a major defeat. It now collects sales tax in NY. (I don't know if they appealed to the U.S. Supreme Court and where that may stand. Amazon has called this "unconstitutional".) Rhode Island and North Carolina are trying to enact such a law presently. Amazon, in a preemptive strike, closed all affiliate accounts in these two states immediately in protest. It is interesting that Amazon feels the affiliates in NY were important enough to keep.Apparently, RI and NC are small potatoes.

Thinking about this, are affiliates really a physical presence? Is there any difference between having an affiliate or purchasing adwords on Google? What if you have a billboard in state? It seems this affiliate business is a backdoor approach to taxing interstate commerce and not a good way to go about it. I have always believed "the ends generally do not justify the means" such that the solution should directly address the problem rather than in some roundabout way.

Whatever the law's tactic resorts to, the more important question is whether online retailers should be taxed or are the exempt by way of interstate commerce? Note that taxing interstate commerce is unconstitional, but sales tax on goods purchased is not. A state has every right to tax something bought in another state. Known as a "use tax", most states require self reporting of these purchases. Think of buying a car at a dealer right across the state line. This happens all the time and you pay the sales tax based on where you register the vehicle. (Car sales are specifically tracked because of the large ticket price; if you bought a $300 lawnmower, no one would report you). Technically, New Yorkers by law should have been paying sales tax on those Amazon books anyway. The interstate tax ban has only to do with taxing "imports" or "exports" between states, not broad consumption taxes. This means that Amazon and other online retailers have been exploiting a loophole as a cost advantage- to the detriment of local commerce and tax revenues.

My conclusion is that sales taxes should be levied and collected on online sales. The problem is that collection can't be enforced on the out-of-state retailer. The Supreme Court ruled on this very issue with regards to a paper catalog retailer in 1992 (remember catalogs?). They agreed it would be too complicated to collect specific taxes for 7,500 jurisdictions. Of course, this was in 1992- right before the internet exploded. Software that does just this was developed and now powers many retailers. It is no longer an administrative burden and no more difficult than processing credit cards. Unfortunately, Congress needs to pass legislation settling the issue since states don't have jurisdiction. What Congressperson is going to propose a bill that will unpopularly support sales taxes on behalf of states and not even the Federal government?