Why Passing Laws Forcing Sales Tax on Out-of-State Purchases is Dumb
By Retrevo CEO & Co-Founder, Vipin Jain
Recently, there has been a lot of passionate debate about sales tax implementation on online purchases. California is the latest to sign into law the collection of sales tax on online purchases made out-of-state through affiliates based in California. This has prompted Amazon, Overstock and others to react and cut ties with thousands of California associates, just like they did in Texas, Colorado, Connecticut, Arkansas, Illinois, Hawaii, Rhode Island and North Carolina. Who is likely to lose in this battle? Amazon? Probably not. The states? Probably yes. Here is why:

  1. When thousands of affiliates lose a significant portion of their revenue, they either go out of business, cut workforce or (a few) evolve to compete using alternate business models. I am fairly certain that the net effect (tax revenue & welfare) will be negative.
  2. On the other hand, large online retailers such as Amazon don't stand to lose much because they can acquire the same customers using alternate customer acquisition strategies, such as CPC (Cost Per Click) or banner advertising. In the most aggressive scenario, all affiliates start sending leads to Amazon instead and get paid more or less the same. So status quo prevails. In a less aggressive scenario, Amazon picks the most important affiliates and spends more with them to generate more leads so they are revenue and gross margin neutral. In this scenario, smaller affiliates are wiped out and the state suffers.

Now, does advertising create nexus? How about participating in out-of-state events to create awareness about your service that can drive a future online purchase? Where is the line? So should we keep the status quo and not tax out-of-state online purchases? Of course not. It is unfair, creates complexity in the short run and harms consumers in the long run.

Why Online Purchases Should be Taxed?
Sales tax is a consumption tax and local communities and the state need it to support their spending - whether it is in the form of sales tax or use tax. Consumers consume local resources that need to be funded (waste and earmarks aside). If we avoid taxes in one place, it will hurt us somewhere else (in the form of another tax or a benefits cut).

Specifically, online purchases should be taxed because:

  1. It is good for consumers: First, we want innovation and a level playing field which will bring more innovation to the market, and help us in the long run. Second, the current method of using big-box retailers as showrooms for online purchases is not sustainable. Some of us still miss the once thriving competition in our local markets, think back to the heydays of Circuit City. According to research, a full 4% of Best Buy shoppers buy at Amazon while 2.7% of Walmart shoppers buy at Amazon. Lastly, we don't want states to get more creative and introduce more complex taxes and reporting rules that create even more headache for consumers.
  2. It is good for online retailers: First, collecting sales tax frees up online retailers like Amazon to not worry about the nexus issue and open up fulfillment centers closer to customers. Can you imagine ordering an item in the morning and getting it delivered in the afternoon at your doorsteps? This would provide real competition to big-box retailers. Secondly, it allows more local innovation from progressive companies that can unite the offline and online experience further. And last but not the least, it is going to get very complicated for shoppers to know who is collecting the sales tax and who is not, and reconcile everything for use tax filing purposes. We can't shift the burden to consumers in order to "simplify" our lives.

What We Need...
We need a simplified consumption tax system that can be implemented and enforced, which has the interest of all stakeholders aligned so they are compliant. Why not simply collect sales tax based on where an item is shipped? Oh, I am sure someone will argue that it is unconstitutional and hinders inter-state commerce (based on some obsolete interpretation of the verbiage in our constitution). Oh wait, why not VAT? Most of the world seems happy with this form of consumption tax that removes the incentive for anyone in the value chain to not collect the tax. May be it is time to learn from others and follow best practices. We did it when we decided to transition from GAAP to IFRS for financial accounting. Even though I imagine widespread support in the congress for such a measure, it will take a lot of political willpower.

In the meantime, large online retailers like Amazon should lead by example and demonstrate that they can continue to innovate and compete on a level playing field. In consumer electronics (one of the largest retail categories for Amazon), Walmart and Best Buy are always playing a catch-up with Amazon and I continue to believe that collecting sales tax will only help Amazon bring more innovation to the market benefiting consumers and company alike. Retrevo is based in California and we collect sales tax in California but we would welcome a more level playing field that promotes innovation.

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