Sales Taxes on Online Purchases: Amazon v. the State of California

I have previously blogged about whether states should have a right to impose a sales tax on transactions made between Amazon and its customers for online purchases when the company does not have a physical presence in that state. The issue has arisen again because Amazon has made an offer to the state of California to build at least two distribution centers and hire as many as 7,000 workers if lawmakers in the state back away -- "at least temporarily" -- from trying to force the Internet giant to collect sales taxes made on purchases made by California customers. The proposal, along with promises to invest as much as $500 million in the new facilities, was made in the form of draft legislation at a meeting last week between Amazon lobbyists and representatives of companies that belong to the California Retailers Association.

The retailer’s trade group and other supporters of California's effort to collect more than $300 million a year in unpaid taxes on Internet sales dismissed the Amazon compromise as a ploy to get the state Legislature to repeal a law that took effect July 1. The statute requires Amazon and other out-of-state Internet sellers to collect California sales taxes. Amazon, so far, has said it would not collect the taxes and has spent more than $5 million on a referendum campaign that would ask voters to rescind the law. The company wants California to refrain from forcing it to collect sales tax until at least January 2014, giving Congress time to come up with a federal law that would replace the growing number of state statutes on the matter.

A bit of history is in order. In a 1992 decision, Quill v. North Dakota, the U.S. Supreme Court ruled that retailers are exempt from collecting sales taxes in states where they have no physical presence, such as a store, office, or warehouse.  (The legal term for this physical presence is "nexus.")   Although the case dealt with a catalog mail-order company, the ruling has subsequently been applied to all remote sellers, including online retailers. The Court said that requiring these companies to comply with the varied state and local sales tax rules would burden interstate commerce. The moratorium is in effect until November 1, 2014. Consumers who live in a state that collects sales tax are technically required to pay the tax to the state even when an Internet retailer doesn't collect it. Good luck on that one.

In its ruling, the Court specifically noted that Congress has the authority to change this policy and could enact legislation requiring all retailers to collect sales taxes without running afoul of the Constitution.  "Congress," the Court declared, "is … free to decide whether, when, and to what extent the States may burden interstate mail-order concerns with a duty to collect use taxes." Amazon's request to delay implementation of a sales tax in California results from proposed legislation called The Main Street Fairness Tax that would push Internet vendors to collect state taxes on items purchased out of state. The logic being it is important to have a federal law so online shoppers in one state with the tax do not have their purchases sent to another state that does not.

In 2008, New York became the first state to further extend the definition of nexus to cover some web-only retailers, including Amazon.com. The legislature passed a bill, accompanying its budget, that said that web retailers have nexus in New York and must collect sales taxes if they have sales affiliates in the state that generate a combined total $10,000 a year or more in revenue for the retailer.   (Sales affiliates are individuals or organizations that are paid commission for linking to the online retailer's web site. Amazon.com has thousands of sales affiliates nationwide, as do many other online retailers.  In all, more than 30 companies are covered by New York's provision.)

On November 4, 2010, a New York state appellate court ruled that New York's law does not violate the commerce or due process clauses of the U. S. Constitution. The case was brought by Amazon.com and Overstock.com, which argued that the state did not have the authority to require online retailers to collect sales tax based on the nexus provided their in-state sales affiliates. Now, several other states have adopted or are considering legislation modeled after New York's. In March of this year Illinois passed similar legislation. Several states are looking to do the same thing to offset lost tax revenue and stimulate local economies in this economic downturn.

From an ethical perspective, I believe the sales tax should be charged on Internet purchases regardless of physical presence. I understand the reasoning of the 1992 Supreme Court ruling and the position of online retailers that no tax should be collected because they do not require local or state resources to support online business. However, Internet sales have exploded in the twenty years since that ruling and it's time for the law to catch up with the technology. I believe sales tax should be based on the fact the company is selling to residents who live in a particular state and those sales provide the basis for the company to be successful and profit. In a sense its very existence depends on these online sales. Moreover, a fairness issue does exist with respect to sellers with a physical presence that provides jobs and stimulates local economies. Why penalize them for providing an essential service?

I am also taken aback by Amazon’s threatening posture in its negotiations with California. The company is acting like a bully; acting as if its services are irreplaceable; and showing no sense of social responsibility. I was quite amused to read last week that an unmanned spaceship funded by Internet billionaire Jeff Bezos, the founder and CEO of Amazon, spiraled out of control and had to be destroyed during a recent test flight. I guess the company will have to wait a bit longer to start selling to customers living in another galaxy.

Blog posted by Steven Mintz, aka Ethics Sage, on September 5, 2011