Question: Introduction As a result of a Supreme Court decision pertaining to catalog sales, Amazon.com and other online retailers were not obligated to collect state and local sales taxes on their online sales unless they had a physical presence or "substantial nexus," such as an office or a retail outlet, in the state. Most states required their residents to pay a use tax on items purchased in other states. For some items such as an automobile, which had to be registered in the state, it was easy to collect the use tax. But, for online purchases few customers paid the tax. Brickand-mortar retailers had attempted without success to convince Congress to overturn the Supreme Court decision and require online retailers to collect sales taxes.129 Customers found Amazon.com attractive because of the convenience of online shopping and also because they could avoid sales tax which could be as high as 9 or 10 percent. Both gave Amazon a competitive advantage relative to brick-and mortar stores, and the substantial nexus decision gave it a competitive advantage over other online sellers such as Barnes & Noble, Home Depot, and Wal-Mart that had a physical presence in nearly all states. The competitive advantage also affected how Amazon organized its business.
It had an incentive to locate warehouses in states without a sales tax, as well as where shipping costs determined where a warehouse should be located. The company placed ownership of the warehouse with a subsidiary, so that Amazon itself had no physical presence in the state. Amazon also had affiliates in each state that placed Amazon links and advertisements on their Web sites and received a payment for each Internet user directed to its site. During the so-called Great Recession of 2007-2009 and its aftermath, online retailers thrived relative to other retailers as cost-conscious consumer flocked to the Internet. Sales of online merchants increased by 4.8 percent, whereas sales at brick-and-mortar retailers decreased by 9.1 percent during the recession.130 The rise of price comparison Web sites also aided Amazon relative to online retailers that were obligated to collect sales taxes. Amazon's sales increased by 40 percent in 2010 to $34 billion, and in the fourth quarter sales were $13 billion. Its sales had broadened, and media products represented less than half of its sales. The recession caused tax collections by states to drop sharply, resulting in large budget deficits in many states.
The states eyed the sales tax revenue lost because of online sales as an opportunity to reduce their deficits and sought ways to force online retailers to collect the tax. The Supreme Court ruling provided protection for online retailers without a nexus in the state, but the concept of a nexus provided an opportunity. New York enacted a law, widely referred to as the "Amazon law," that defined an affiliate as a sales agent and declared that the 129See the case Internet Taxation in Chapter 8. 130www.foxnews.com, June 19, 2011. presence of sales agents in the state constituted a nexus. Several other states followed New York's lead, and others such as Texas decided that a warehouse owned by an Amazon subsidiary was a nexus and sent Amazon a bill for back taxes. Other states contemplated similar laws. Amazon faced the challenge of both defending the status quo at the federal level and dealing with the state initiatives. The state initiatives posed the immediate threat. The Alliance for Main Street Fairness which backed Internet sales taxation had turned its attention from Congress to the states and took out full-page newspaper advertisements featuring excerpts from local newspapers advocating taxation of online sales.
The Alliance was backed by big-box retailers including Wal-Mart, Target, Best Buy, Sears, and JC Penny. Background The Supreme Court held in Quill Corp. v. North Dakota, (504 U.S. 298, 1992) that the Commerce Clause of the Constitution prevented a state from requiring a mail-order company to collect sales tax on purchases by residents unless the company had a physical presence, or substantial nexus, in the state, since collections would be burdensome and impede interstate commerce. Online retailers relied on this decision to avoid collecting sales taxes in states where they did not have a nexus. Most states had both sales and use taxes. Residents of a state that purchase items outside the state were required to pay to their resident state its sales tax applied to the purchase price. Few residents paid the use tax. Of the 50 states only Alaska, Delaware, Oregon, Montana, and New Hampshire had no sales tax, although Delaware has a gross receipts tax. Amazon collected sales taxes on purchases by residents only in Washington, Kansas, Kentucky, and North Dakota, where it had sales operations, and in New York while it appealed a court decision.
The National Conference of State Legislatures estimated that uncollected sales taxes on online and mail-order sales were $8.6 billion in 2010. A University of Tennessee study estimated that uncollected taxes on Internet sales would be more than $11 billion by 2012. However, a study by Navigant Economics for NetChoice, an association including as members eBay, Expedia, Oracle, Overstock.com, and Yahoo, estimated the tax loss at only $4 billion a year.131 The California Board of Equalization, the tax collecting agency of the state, estimated that in 2010 the state lost $1.15 billion in uncollected sales taxes from online shopping and catalog sales. Of that amount $795 million was from consumers with the rest from businesses. There were approximately 7,500 jurisdictions in the United States that imposed a sales tax, and online and catalog retailers argued that the complexity associated with applying the tax rates to each purchase would be overly burdensome, particularly to small retailers. A group of 23 states participated in the Streamlined Sales Tax Governing Board to simplify and harmonize sales taxes across the states.
Twenty advisory states also participated, but the complexity of the task was considerable. The group had to decide issues such as "whether a Twix bar is a cookie and exempt from sales taxes or a candy that isn't exempt."132 Scott Peterson, executive director of the group, said, "I think we're soon getting to a point where Congress will have to enact a law giving states authority to require out-of-state online retailers to collect local sales taxes."133 Mary Osaka, spokesperson for Amazon, said, "We are not opposed to collecting sales tax within a constitutionally permissible system applied even-handedly."134 The Threats from the States The tax laws affected Amazon's organization, its location decisions, and its strategy more broadly. Amazon located its warehouses based in part on shipping costs and in part on tax considerations. For tax purposes Amazon had incentives to locate in states in which it necessarily had a physical presence, which had no state sales tax, and where sales were relatively low as in the case of a state with a small population. Where shipping costs dictated the location of a warehouse as in the case of Texas, Amazon had established a subsidiary to own the warehouse under an "entity isolation" strategy, allowing the company to claim that the warehouse was not a nexus.135 Amazon maintained that a nexus was necessarily something that sold products, whereas a warehouse only shipped products. Amazon's warehouses were located in its headquarters state of Washington and in Texas and several other states.
Amazon supported its marketing through arrangements with "affiliates"-Web sites on which Amazon advertised and paid the affiliate for each user directed to Amazon's Web site. States began to counter Amazon's strategy by rewriting their laws to designate affiliates and warehouses owned by a subsidiary as nexuses. Amazon responded not only by contesting the state laws but also by removing the newly designated nexuses. New York New York was the first state to enact an Amazon law. The 2008 law stated that a remote vendor, that is, Amazon, that enters into an agreement with a resident who refers customers to the vendor and receives in exchange a commission is an "instate vendor." By this definition Amazon's New York affiliates made it an in-state vendor that was required to collect the sales tax on sales to New York residents. The implicit claim was that Amazon had a substantial nexus in the state, and hence was not protected by Quill. Amazon filed a lawsuit challenging the law, but collected the state sales tax as it contested the law in the courts. Lower state courts upheld the law, and Amazon appealed their decisions. 132DallasNews.com, April 14, 2010. 133Ibid. 134Washington Post, May 2, 2010. 135The subsidiary was named Amazon.com KYDC LLC. (Wall Street Journal, August 2, 2011) Colorado Colorado took a somewhat different approach to collecting taxes on online sales. It required online sellers to notify Colorado customers on each transaction that they owed sales and use tax and to provide them with a year-end statement of their purchases.
The law enacted in 2010 also required the online retailer to provide the state department of revenue with a statement summarizing the online purchases of each customer with a Colorado shipping address and the amount of their purchases. The online retailer could avoid the notification and reporting requirements if it collected and remitted the sales tax. Amazon responded quickly to the enactment of the law by severing its relationships with its Colorado affiliates. In an e-mail to its Colorado affiliates Amazon wrote, "We and many others strongly opposed this legislation ..., but it was enacted anyway. There is a right way for Colorado to pursue its revenue goals, but this new law is a wrong way."136 Governor Bill Ritter Jr. responded, "Amazon has taken a disappointing-and completely unjustified-step of ending its relationship with associates. While Amazon is blaming a new state law for its action, the fact is that Amazon is simply trying to avoid compliance with Colorado law and is unfairly punishing Colorado businesses in the process." Former affiliate Brad Feld wrote, "[T]he many small businesses and solo entrepreneurs who make money off of Amazon's affiliate program just lost a revenue stream (which, by the way, is used to employ people and pay states taxes)."137
The local activist group ProgressNow Colorado called for a boycott of Amazon "until Amazon.com stops using Coloradans as pawns."138 Rebecca Madigan, director of the Performance Marketing Association of affiliates, said, "States say they are doing this to generate revenue. But these laws won't achieve this objective because the states won't get the sales tax once online retailers such as Amazon drop their affiliates. At the same time, there will be a reduction in state income tax paid by affiliates as they lose revenue from Amazon. Logic is on our side."139 Closing affiliate programs was believed to have little effect on Amazon and other large online retailers. Jonathan Johnson, president of Overstock.com which had also severed ties with its affiliates, said, "We ended them in New York, Rhode Island and North Carolina, and it hasn't hurt our sales. People like to find coupons and deals from affiliate members. If they don't find them from a Los Angeles- or San Bernardinobased affiliate marketer, they'll find them from someone in Dallas or San Antonio."140 Ken Rockwell, who operated an affiliate Web site, commented on the pending legislation in California which he said would cost him 90 percent of his income: "I happen to be in California, but I can do what I do if I move to Tahiti or the south of France."141 Barnes & Noble saw an opportunity and invited former Amazon affiliates in states with "e-fairness legislation" to "These new tax laws affecting affiliates are supported by the national retailing chains that covet the affiliate advertising programs of their competitors."158 The Virginia legislature took up the issue of an Amazon tax based on designating affiliates as constituting a nexus. Chris Manns had successfully built a price comparison Web site CheapestTextbooks with 10 employees and was an Amazon affiliate, receiving income for customers referred to Amazon. He testified that he would have to move out of the state if he were cut off by Amazon. The bill to impose an Amazon tax died, but the sponsor promised to reintroduce it next year.159 Amazon had planned to open warehouses in South Carolina and Tennessee with the warehouses owned by subsidiaries. Amazon insisted on a tax exemption in Tennessee.
An exemption from the collection of the state sales tax in South Carolina had expired, and Amazon sought assurances that it would not be required to collect the tax. A spokesperson for the South Carolina governor said, "The governor is taking a hard look at the issues surrounding Amazon. Economic development and job creation are two of her highest responsibilities and priorities, and while the governor wants to make sure we keep promises made to companies, she also wants to make sure we are being fair to the companies we already have in the state."160 California California's Democrat-controlled legislature passed an Amazon law in 2010, but it was vetoed by Republican governor Arnold Schwarzenegger. In 2011 Assemblywoman Nancy Skinner reintroduced an Amazon tax bill based on the New York bill stating, "Out-of-state online retailers designed their business model to avoid collecting sales tax. This puts our Main Street businesses, which play by the rules, at a competitive disadvantage. It's not fair to hurt California businesses that are struggling to keep their doors open."161 Rosemary Rodd, who owned a professional audio store, said, "We get people who come in here and try the thing out and talk to my people about what works best for them.
Then they buy it on the Internet and tell me, ‘I'm a musician. I'm broke. The $200 I saved was just too much.'"162 Democrat Betty Yee, a member of the State Board of Equalization, said, "I've gone into Home Depot, and it's practically empty. It's like one big showroom now. Consumers go in and touch and feel and test products, and then they go home and order online from out of state."163 The bill was backed by the California Retailers Association. Barnes & Noble vice president Gene DeFelice said, "We are at a serious competitive disadvantage."164 The Direct Marketing Association representing online retailers opposed the bill. eBay complained that the bill would force out-of-state sellers to collect taxes on sales to California residents, imposing a heavy 158Wall Street Journal, March 17, 2011. 159Washington Post, May 2, 2010. 160New York Times, March 14, 2001. burden on small sellers. David London of eBay said, "Tax barriers that block small business from using the Internet will stifle job growth, reduce competition for retail giants and undermine entrepreneurial small businesses trying to spur economic growth."165 Rebecca Madigan representing 25,000 online affiliates in California said, "Out-of-state advertisers will simply stop advertising on the California websites to avoid having to collect California sales tax."166 With a new Democrat governor taking office in 2011 and an enormous state budget deficit, the tax bill received new life.
The legislature passed the bill and the governor signed it. As in the laws adopted by other states, affiliates were designated as constituting a physical presence. Amazon had 10,000 affiliates in California, and another 2,000 online retailers in the state were estimated to have 15,000 affiliates. The bill contained two provisions specifically directed at Amazon. One provision let the state collect sales tax from an online retailer that either itself or through a subsidiary develops products sold by the retailer. This would potentially cover Amazon's subsidiary A2Z Development Centers Inc. that had an office in Studio City that handled online advertising and Lab126 in Cupertino that developed Kindle book readers. The other provision, known as a "long-arm statue," allowed the state to determine which businesses were responsible for collecting sales taxes.167 Yee said, "The world of commerce has changed so must that physical presence does not necessarily mean having a brickand-mortar physical location."168 A spokesperson for Governor Jerry Brown explained, "Our stance is simple: thousands of brick-and-mortar businesses in California follow the law and collect sales tax every day. We expect Amazon to do the same."169 Upon enactment of the law, Amazon severed ties with its affiliates, as did Overstock.com and hundreds of other online retailers. In an e-mail Amazon wrote, "We oppose this bill because it is unconstitutional and counterproductive. It is supported by the big-box retailers, most of which are based outside California, that seek to harm the affiliate advertising programs of their competitors."170 Affiliate Ken Rockwell said, "This is not good for anybody, and it affects the companies who pay me.
It seems like the government is messing with something that it really doesn't understand. A lot of people make a few dollars here and there by being affiliates, and they really need the money."171 One alternative for Amazon was to file a lawsuit against the state in an attempt to block the law, and another was to move its subsidiary and lab out of the state. Amazon could also join with other online retailers and the former affiliates and attempt to reverse the state's action in the legislature. The online sales tax bill was passed during a budget emergency in the state, and as the economic recovery sputtered, state tax collections remained uncertain. The economy in California lagged behind the rest of the country, and the unemployment rate was higher than the national average. Another alternative for Amazon was to turn to the voters. California had a citizens' initiative process in which signatures could be collected to put a measure prohibiting online taxes on the ballot for a direct vote. Approximately 434,000 signatures would be required, and Amazon had hired an in-state consultant for advice on the initiative alternative.
Amazon vice president Paul Misener explained, "At a time when businesses are leaving California, it is important to enact policies that attract and encourage business, not drive it away." He called the possible ballot initiative "a referendum on jobs and investment in California."172 He added, "Californians deserve a voice and a choice about jobs, investment and the state's economic future."173 In response, a group of NGOs set up a Web site and called for a boycott of Amazon. Jessica Lehman of Community Resources for Independent Living said, "If Amazon.com won't contribute to California, then we won't contributed to Amazon.174 As an alternative to a contentious ballot initiative, Amazon made an unusual offer to the state of California. It offered to 172New York Times, July 12, 2011. 173New York Times, July 14, 2011. 174San Jose Mercury News, August 16, 2011. build five distribution centers, employing 7,000 in the state if the state would impose a moratorium on its online sales tax collection until 2014. The moratorium would provide time for Congress to enact a federal law to deal with online sales taxation. The unemployment rate in the state was 2 percent higher than the national average of 9.1 percent.
1. How serious is the threat of an online sales tax to Amazon? How would sales be affected if Amazon were required to collect sales taxes in all states? How would profits be affected?
2. What overall nonmarket strategy is Amazon using to deal with the sales tax issue? What is its relation to its market strategy?
3. Is Amazon acting responsibly in terminating its relationships with associates in states that enact an Amazon tax?
4. Should Amazon have closed the warehouse in Texas?
5. What should Amazon do in California? Should it continue with the ballot initiative? Was its moratorium proposal wise?
6. What strategy should Amazon adopt to address the online sales tax issue at the federal level?