California Governor Jerry Brown has put the final stamp on a law that will force online retailers to collect sales tax from customers. However, there are a few distinct details to this new law that should probably be explained. First, the rules of the game: the US Supreme Court has held (since 1992) that a seller must first have a “physical presence” in the state before it can collect sales tax. California’s new law defines that physical presence in 2 ways: one is by having “affiliates” who refer customers in return for a commission that are located in CA, and the other is by having a “related company” operating in CA. I would think that the first method is pretty clear and probably establishes a presence in a state. The second method seems a bit vague and too open to varying interpretations, so stay tuned for the inevitable lawsuits. I think that the fact that Amazon has not closed their other companies in CA suggests that they believe the latter method to pose legal problems to CA.
The target of this new law is Amazon.com and other big-bore online retailers. CA businesses with actual stores have long complained that online retailers were enjoying a competitive advantage. However, if one looks at, say, Target and Walmart, those stores continue to thrive, despite competing with Amazon nationwide. So, perhaps the claim that government needed to step in to level the playing field is a bit overblown. Also, there is almost zero mention of the numerous wage and hour cases that have been successfully brought against Walmart. So, perhaps protecting Walmart is not actually good for jobs?
The upshot of this new law appears to be that Amazon and other on-line retailers are severing their relationships with their CA affiliates. This means that a number of CA businesses will no longer earn money on commissions from these online retailers. According to the LA Times’ article, the CA affiliates paid a combined $152 million in state income taxes last year. CA hopes to raise $317 million in new taxes. Keep in mind that CA began 2011 with a projected deficitof $26.6 BILLION!!! CA is also reducing the sales tax by 1%, or rather, the 1% tax hike from 2 years ago is expiring and will not be renewed. It may be that if online retailers sever their affiliates and therefore do not have to collect these taxes, CA makes nothing, and if the affiliates leave, CA loses revenue from income tax.
While it’s unclear what the ultimate outcome of this move will be, a few things are clear, beyond the simple reality of CA owning a broken economy. By forcing Amazon et al to start collecting sales tax, CA has reduced the online retailers’ ability to compete in the market. Amazon, for one, has done the calculus and determined that the reduced competitiveness coupled with the commission payouts hurts their profits. In short, Amazon has decided that it’s better to cut the commissions and lose the referrals but retain the ability to compete in the marketplace. This forces the affiliates to make a choice: lose the commissions or move out of CA. It remains to be seen whether people leave CA in droves and reduce the tax base. Jerry Brown is gambling that they won’t. What we are seeing is the direct result on business decisions that taxes and other gov’t regulations have. We are quickly approaching a tipping point where inhospitable conditions for doing business and uncontrolled spending by government will force companies to relocate.