Round 1, Fight! Amazon.com Versus State Taxes

Since the recession began, politicians of both parties have spoken about the importance of economic growth. President Obama’s stimulus bill, for example, was said to be conducive to job creation and business expansion. But while nationwide unemployment is more than 10%, some states are adding insult to injury with their own policies. The battle Amazon.com is currently facing against 16 different states is a case in point. In each of those states, lawmakers are attempting to single out Amazon resellers for a new tax above and beyond their existing income taxes. The goal, states say, is raising more government revenue at a time when it is scarce. But economists (and Amazon itself) say that the states are cutting off their nose to spite their face. Instead of increasing government revenue, as governments hope, the proposed new tax is proving to be economically destructive wherever it is imposed.

Business Pundit explores the issue in greater detail below.

Amazon Associates & Taxes

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Most people know about Amazon, what they do and why they’re so successful. Fewer people, though, are aware of something called the Amazon Associates program. The Amazon Associates program falls into a broader category of business called affiliate marketing, which is when individuals sell the products of other companies for a commission. Tens of thousands of people in America (and even more worldwide) make their full or part-time living from affiliate marketing and Amazon proudly states that its Amazon Associates platform is “the web’s most popular and successful affiliate program.” What it has done is create a global army of resellers who earn up to 15% in referral commissions for selling Amazon’s products on their own websites, through e-mail or innumerable other methods. Besides providing incomes for many thousands of people, those same people, in turn, pay taxes on their earnings from participating in the Amazon Associates program. And Amazon benefits by paying its resellers only for pure performance (that is, when they successfully sell Amazon products.)

In other words, the current arrangement is profitable for Amazon, its resellers and all the governments who tax their activities. Everyone is better off.

The Problem

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It should be made clear before going further that the income-generating parties here are not the state and federal governments. The income-generating parties are Amazon and its resellers. Without them, there would be no profits for either state or federal governments to tax away. Unfortunately, as is typical politician behavior, state governments are killing the proverbial goose that lays the golden egg. As WalletPop reported on March 18 2010, sixteen states are trying to force Amazon to collect sales taxes in every state where its affiliates operate. Here is the “problem”, from a state government’s point of view. Amazon itself already collects sales taxes on when it sells to customers in states where Amazon has a presence: Kentucky, North Dakota, Washington and New York. But people in any state can resell products via the Amazon Associates program. Therefore, some states are arguing, why shouldn’t sales tax be collected when an Amazon affiliate in, say, Connecticut sells Amazon products? If implemented, this would result in Amazon affiliates being taxed twice on their affiliate profits – once in the form of personal income taxes (which they already pay) and again in the form of sales taxes.

The latter has been termed the “Amazon tax” by economists, journalists and Amazon itself.

The States Involved

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As MSN revealed, sixteen states had already enacted or contemplated enacting some form of the “Amazon tax” as of March 16, 2010. Those states are: California, Colorado, Connecticut, Hawaii, Illinois, Iowa, Maryland, Minnesota, Mississippi, New Mexico, North Carolina, Rhode Island, Tennessee, Vermont, Virginia and Wisconsin. MSN’s Kay Bell elaborates that lawmakers in these states “contend this affiliate arrangement is enough of a nexus, that is, an actual state presence” to justify the collection of sales taxes from Amazon affiliates. Connecticut, in particular, has drawn the ire of Amazon with its attempt at singling out Amazon resellers for sales taxes. In a published complaint to Connecticut’s General Assembly, for example, Amazon VP of Global Public Policy Paul Misener emphatically stated the law was “unconstitutional and would produce little or no revenue for Connecticut.”

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Consequences to Amazon & Resellers

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Later in the same complaint, Misener made clear why the Amazon tax will produce little revenue for Connecticut or the other sixteen states. Very simply, Misene writes, “Amazon and presumably dozens of other out-of-state retailers would simply sever affiliate advertising relationships with Connecticut residents” if these taxes stand. Meanwhile, citizens of other states without such taxes could still freely participate in Amazon Associates and other affiliate programs. It all comes down to incentives and opportunity cost. Harvard MBA John T. Reed wrote an article on singling out activities for unique or higher taxes, and touches upon Amazon’s situation specifically:

“Those affiliates—local persons who were helping Amazon sell books and stuff and who were getting paid by Amazon for doing so were all put out of the Amazon business. Those people had been paying state income tax on their Amazon earnings. Now their Amazon earnings are zero, lowering the amount of state tax they pay. And the sales tax paid by Amazon did not go up from zero. It is still zero. All the politicians in those states accomplished was knocking a bunch of their own small businesspeople out of business. Way to go geniuses!”

In other words, as Misener promised, Amazon has already begun terminating affiliate relationships in states that are trying to impose this tax or have already imposed it. Keeping affiliate relationships in those states would require Amazon to know the state and city tax rates for every single city in which it had affiliates. Furthermore, because “states have not found a way to get residents to voluntarily pay sales tax on Internet sales, or for sellers to voluntarily collect it”, WalletPop explains, these sixteen states expect Amazon to do it for them. But unlike politicians, who frequently pass the costs of their decisions on to others, Amazon must confront the opportunity cost of such an arrangement. And besides staying abreast of all the tax rates in cities and towns nationwide, Amazon would also be obligated to do all of the bookwork involved in cutting checks that reflect the sales taxes being collected.

In short, the various “Amazon taxes” proposed by these sixteen states are making it less advantageous to be an affiliate (or run an affiliate program at all, in Amazon’s case.) As Reed concludes:

When you tax something, you get less of it.
When you subsidize something, you get more of it.

Sure enough, the Tax Foundation reveals that “the nation’s first few Amazon taxes have not produced any revenue at all, and there is some evidence of lost revenue.” Contrary to the original situation, everyone involved – Amazon, its affiliates and the state governments involved – are now rapidly becoming worse off.

The Future

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Frightening as the “Amazon tax” is for Amazon and its affiliates, it also signals what could become a dark trend for affiliate marketing as a whole. In principle, there is no difference between the arrangement between Amazon and its affiliates and, say, the relationship Commission Junction or PepperJam has with theirs. If these sixteen states are successful at upholding Amazon-esque taxes (and driving affiliates out of business), that outcome could become the norm for affiliate marketing in general, in all states. That would be especially unfortunate while we are in the teeth of a recession. Citing the most recent data available, Wikipedia states that “affiliates worldwide earned US$6.5 billion in bounty and commissions from a variety of sources in retail, personal finance, gaming and gambling, travel, telecom, education, publishing, and forms of lead generation” in 2006. The imposition of taxes that make it less worthwhile to be an affiliate or run affiliate programs threaten to shrink the United States portion of those revenues, potentially to zero.