Tax revenues have been plunging during the current recession, and states have been scrambling for ways to bolster their depleted coffers by looking online.
While the governors of two states this year rejected budgets forcing residents to pay sales taxes on purchases from out-of-state Internet retailers such as Amazon and Overstock, two states—North Carolina and Rhode Island—passed budgets that included the tax. New York residents, meanwhile, also have to pay.
These developments are troubling.
In our federal system, states can tax only entities within their borders. Amazon’s Washington state headquarters, for example, is three time zones away from the Albany, New York statehouse. So what gives?
Justifying an Online Tax
The logic goes like this: Amazon works with affiliates who advertise and link to products it sells. These affiliates are scattered throughout the 50 states. Therefore, Amazon has a physical presence in each state and can be made to collect and pay sales taxes in each state.
There’s only one problem: Amazon does not own its affiliates. They are separate businesses that Amazon pays to drive shoppers to its site. They are outside contractors and are not part of the company.
Under this taxation-by-affiliate approach, someone who lives in Minnesota could be made to pay California taxes simply because they do business with someone in that state.
Why are state politicians trying to do this? Quite simply, they need money, and Amazon and its customers have it.
Better to Control Spending
These revenue grabs are the direct result of a nationwide government spending problem. California is spending so much money it has had to resort to issuing IOUs instead of checks. Roughly every fifth dollar North Carolina spends is one it does not have. New York’s state budget deficit is more than $16 billion.
But the effects of the proposed tax increases won’t be limited to Internet retailers and spendthrift state legislators. Shoppers in the affected states will have to pay more for the same goods. That leaves them less money for other job-creating purchases.
There are solutions to state budget woes that do not involve taxing out-of-state companies and would not cost jobs. Cutting spending is an obvious choice. There is plenty of fat to trim.
Good Times Are Gone
New York, for example, sets aside money in its budget for obvious nonessentials such as the Urban Yoga Foundation and the Utica Curling Association. California’s budget is on the hook for literally billions of dollars worth of fraudulent welfare payments.
States could afford these indulgences when economic times were good, and indulge they did. But income tax revenues are down roughly 26 percent from last year, even as spending continues to climb.
When you are making less money, spending less is the responsible thing to do. But responsibility is sadly out of fashion in this age of bailouts and stimulus packages.
Won’t Raise Revenue
The real kicker is that the Amazon tax might not actually raise any revenue. Amazon recently severed ties with all of its North Carolina and Hawaii-based affiliates, removing any possible claim to a physical presence in those states. Overstock has cut off its affiliates in all five states that have passed or are seriously considering the Amazon tax, and it has sued New York State, costing taxpayers substantial legal fees.
Jobs already have been lost. Consider, for example, the workers at affiliates who are now, shall we say, unaffiliated. Overstock was working with 3,400 affiliates in New York alone. Throwing these people out of work at a time when unemployment is at a 26-year high is very bad policy.
Ironically, the Amazon tax is not only unlikely to raise revenue, it will also decrease income tax revenue. If fewer people are working fewer hours, they are making less income that can be taxed. Thus the Amazon tax appears astoundingly counterproductive.
Economists have known for a long time that when you tax something, you get less of it. Apparently some state legislators want less commerce in their states.
Ryan Young ([email protected]) is a fellow in regulatory studies at the Competitive Enterprise Institute in Washington, DC.