Amazon, Sales Tax, and Unintended Consequences

There is a rule in business: if you put a bucket of money on one side, a profit maximizing enterprise* on the other, and some sort of legislation in between, eventually that enterprise will find a way to get to that bucket of money. Economists call this an unintended consequence of the legislation because the cleverness with which rules are circumvented is rarely foreseeable…at least to politicians.


The latest display of this stalwart economic principal is the fight between Amazon and various state legislatures throughout the country who are now demanding that Amazon pay sales taxes in those states where affiliates or subsidiaries operate. The argument behind the proposals are two fold. First, if brick and mortar facilities have to pay sales tax it is only fair that online businesses do the same.  Second, as the current debate in Wisconsin indelibly demonstrates, states are in a pinch when it comes to their budgets.


Let’s take these one at a time.  The idea that online retailers paying sales tax is a matter of fairness is nonsense. At the heart of these arguments is the notion that somehow e-commerce is unfairly competitive with respect to businesses with physical retail spaces. These two types of business models are simply competitive along different dimensions.


While online sellers may enjoy a price and volume advantage in many cases (although this is by no means universal, think: Wal-Mart), they relinquish many other advantages.  First, customers must pay shipping expenses and even then must wait several days to receive their product. They risk having the product damaged during transit or missing the UPS driver if the item requires a signature. They don’t get to skim through the book, try on the skirt, or smell the candle. They don’t get to ask a sales person for advice or have him/her answer questions about the product. If the customer guesses wrong while shopping online, they don’t get the immediate feedback to know that the salesperson should bring them a smaller size of shoe. They don’t get to see colors and textures of fabrics in eye-poping REAL-D or in the unforgiving light of the real world. They don’t get to pick up the computer to see how light 5.1 Ibs really feels.  The customer won’t get to see the brightness of the HDTV, judge the size of the suitcase, or feel the firmness of the pillow. And trying to return something you bought online? If that online retailer doesn’t have a physical store nearby you’re off to the post office to wait in a 10-person line, destined to mail the item back and start the buying process all over again.


I could go on, but anyone who has been to an Apple store lately surely must know the value of a physical retail location. Daily, crowds of consumers pack between its walls to look, feel, hear and yes, purchase.


So how are online retailers stacking up against brick and mortar stores these days? I pulled this report from the US Census website:

E-commerce sales in 2010 accounted for 4.2 percent of total retail sales. In other words, less than $1 of every $20 a customer spends will be through an web-based vendor. Although online sellers are certainly increasing at a healthy pace, it looks like traditional retailer stores are still doing just fine.


Now what about those state budgets. The theory goes that forcing online retailers to pay sales tax will increase tax revenue thereby helping to close budget gaps. While that might work in a world where people’s feet are sealed in concrete, the real world is dynamic—companies and consumers constantly respond to the incentives laid out before them. So what do you do when someone slides a piece of legislation between you and a bucket of money?  You find a way to get to the bucket:

“Meanwhile, last fall, Texas officials sent Amazon a tax bill for $269 million, after determining that the retailer’s Dallas-area warehouse, owned by a subsidiary, qualified as a local address under state tax rules…In retaliation for Texas’s move, Amazon said last month that it would close the warehouse next month and cancel plans to build another.”


If this movement among states continues to gain steam, then Amazon will continue to respond, probably by consolidating its operations to minimize its tax exposure; all the while hurting the states that enact the legislation by reducing employment opportunities. At some unknown point in the future, I predict, some clever state will realize what is happening and invite online retailers by exempting them from sales tax—because states want to get to that bucket of money too—just as Delaware did with laws regulating incorporation of businesses. Laws which have since spread to other states, I might add. (Either that or Amazon will simply relocate to one of the four states with limited or no sales tax). And this certainly wouldn’t be the first time that companies have undergone geographic relocations in response to legislation.


*Note that humans are included as profit maximizing “enterprises”.


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