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Supporters of "Amazon Taxes" Ignore Economic Ineffectiveness

David Godow
March 18, 2011, 3:13pm

Yesterday, the New York Times ran an unfortunate editorial praising the efforts of state governments to shanghai online retailers like Amazon.com into collecting sales tax as part of its operations. The piece asserts that states are "losing" hundreds of millions of dollars in potential tax revenue by not going after the freedom online retailers enjoy from sales tax. It goes onto applaud the "new legal tools" states are employing to bring nasty tax-dodging online shops to heel, and exults over the success of some states in doing so.

Hold up. This battle has been going on for almost three years -- the first such tax was passed in April 2008 -- and the states that have "successfully" passed bills extending sales tax to online retailers are actually worse off than those that haven't. New York, Rhode Island and North Carolina all adopted such measures, only to take in zero tax revenue.

The problem is that it's easy for retailers to avoid collecting sales tax even after states have passed measures forcing them to do so. That's because these new laws rely on retailers' in-state "affiliates" or "associates" -- third parties that advertise for a retailer on their own websites and receive a commission for doing so. The new wave of "Amazon tax" laws rely on those people to establish retailers have a "physical nexus" in the state, a necessary condition for collecting sales tax. When one of these bills is passed, Amazon has simply axed their affiliates, cutting off their "nexus" and solidfying their tax exempt status. Check out a more detailed review of the Amazon tax issue courtesy of the Tax Foundation's Joe Henchman.

Not only does this mean no tax revenue for states, but it robs affiliates of their commissions. This means less income earned in the state and, as a result, less paid in income taxes into state coffers. In what sense is this a win?

Still, it's understandable why state governments might pursue laws like these even if they are futile in the short term. Ultimately, they want to build momentum for a federal measure that would force all retailers, whether brick-and-mortar or online, to collect sales tax on each transaction based on the location of the purchaser.

Some see this as a way to level the competitive playing field between traditional and digital venues, others see it as a rollback of the principles of tax tourism. Those of the latter view argue that by disconnecting sales tax paid from the location of the seller, states lose the incentive to offer a more competitive tax environment than their neighbors. If Amazon had to remit sales tax for based on the laws in the purchaser's neighborhood (rather than the low-tax mecca of Delaware, where it's headquartered), states and cities would rest easier about jacking up their own taxes. After all, it wouldn't matter if businesses threatened to pull their physical operations out of a state; they'd still have to pay the local tax if they wanted to do business there. The advantages that states like Delaware, which fight to remain attractive locations for businesses, would disappear.

This is really the core of the argument: should states have the authority to tax all sales within their borders, or only those made by sellers physically located in the state? As Henchman notes, the prospect of navigating 8,000 separate sales tax jurisdictions could involve serious costs to retailers like Amazon. It was this potential burden that motivated the Supreme Court to establish the "physical nexus" requirement in the first place [see Quill v. New York (1992)].

It's clear that the fight to preserve federalism in sales taxes is one for the future. In the meantime, states should avoid punishing the entrepreneurs who stock online retailer affiliate programs with useless attempts to "force" such companies to pay sales tax. Pursuing such measures is an irresponsible waste of legislative resources while budget deficits loom over every state in the Union. How many more failures will it take for lawmakers to recognize this?


David Godow is Research Assistant


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