A Taxing Question

Online shopping is about to get more expensive. Currently, Americans who shop over the Internet from out-of-state vendors aren't always required to pay sales taxes at the time of purchase. For the past seven years, online sellers have argued successfully that bizarre distinctions between definitions of taxable and non-taxable items as well as the existence of more than 7,000 different tax agencies is why online sales should not be taxed. Pro-tax officials and state governments have been pressing Congress to enact online taxes arguing that reduced sales tax revenue threatens budgets for schools and police, and say that, as a matter of fairness, online retailers should be forced to collect the same taxes that brick and mortar retailers do. If online retailers were, like their land-locked colleagues, required to collect the taxes at time of purchase, tax collectors would unlock a virtual flood of cash to support strapped state finances. According to an estimated by University of Tennessee researchers in a 2009 report, state and local governments this year will lose $10.1 billion to $11.3 billion in sales taxes not collected by Web retailers. Taxes are coming to the Internet!

As of July 1, 2011 California enacted a state law that requires large out-of-state retailers to collect sales taxes on purchases that their California customers make on the Internet. "Getting the taxes, which consumers typically don't pay to the state if online merchants don't charge them, is "a common-sense idea," said Gov. Jerry Brown, who signed the legislation into law. The new tax collection requirement is expected to raise an estimated $317 million a year in new state and local government revenue.

However, there is another law which also came into effect in California, the law of unitended consequences. The new California tax law applies only to online sellers based out of state that have some connection to California, such as workers, warehouses or offices there. So, in response to the new law, both Amazon in Seattle and Overstock in Salt Lake City have told affiliates that they would have to move to another state if they wanted to continue earning commissions for referring customers. As an unintended consequence, many of approximately 25,000 affiliates in California, especially larger ones with dozens of employees, are likely to leave the state, said Rebecca Madigan, executive director of trade group Performance Marketing Assn. According to Madigan, the affiliates combined paid $152 million in state income taxes last year.

California is the seventh and largest state in the country to pass a law to collect taxes on out-of-state Internet sales. Illinois, Arkansas and Connecticut acted earlier this year, North Carolina and Rhode Island in 2009 and New York in 2008. Amazon sued to overturn the New York law and lost in the lower courts. The company is paying sales taxes into an escrow account pending an appeal.

Taxing internet sales is bad news for online sellers, who’ll lose a 5 percent to 10 percent pricing edge over their brick-bound competitors, which helps to offset shipping costs, and it’s good news for conventional retailers, who won’t be hampered by that pricing burden. As you might expect, Amazon is leading the fight against collecting taxes using all strategies at their disposal including declaring the law unconstitutional and counterproductive and collecting signatures on a petition to overturn the California law. Credit Suisse recently estimated that if Amazon were forced to collect sales taxes in all states, it would lose as much as $653 million in sales this year, or 1.4% out of an estimated $45.5 billion in revenue. Amazon's Mr. Bezos has said he established the company in Washington partly because it has a tech-savvy but relatively small population, so state taxes wouldn't affect many potential customers.

Online auction giant EBay Inc. is taking yet another anti tax approach claiming it would "harm small Internet retailers" that sell products using the EBay website. "Forcing small businesses to take on the same costs and tax burdens as national retail businesses is unrealistic, unfair and will unbalance the playing field between giant retailers and small business retailers on the Internet," said Brian Bieron, EBay's senior director of federal government relations and global public policy.

States have responded with the Main Street Fairness Act, which would require states to sign a Streamlined Sales and Use Tax Agreement before they could require retailers to collect the Internet sales tax. That agreement, signed by 24 states so far, would create a uniform national standard for collecting state and local sales taxes. Such simplification is aimed at satisfying the Supreme Court's concern that requiring Internet sellers to collect sales taxes is a burden that unconstitutionally interferes with interstate commerce.

Even as Amazon and other mega online retailers try to hold back the oncoming flood of online taxes, the desperate need for additional state revenue appears to be too much for the etailers to overcome. The next question is how the taxes will impact ecommerce sales.