The Taxman Clicketh

State lawmakers last week passed the largest tax increase in California history, and will soon consider taking their expanding quest for revenue online. A proposal by Assemblywoman Nancy Skinner (D-Berkeley) would force many Internet retailers to collect sales tax on all orders placed by California consumers. Based on a similar law in New York dubbed the “Amazon tax,” AB 178 would unnecessarily raise prices, threaten small businesses, and throw a wrench into a thriving e-commerce industry.

If Californians must pay sales tax when shopping at brick-and-mortar stores, why shouldn’t the same rules apply to online purchases? Such a proposal appears fair and equitable, and Skinner justifies its purpose as “leveling the playing field.” Unlike stores that conduct all sales from a physical location, however, Internet businesses seamlessly reach customers all over the world. Because tax rates and rules vary between counties and cities, American visitors to an online storefront hail from more than 8000 tax jurisdictions.

Requiring Internet businesses to tabulate and collect sales tax for every possible jurisdiction would pose a costly burden. Companies would need an army of specialists to monitor 10,000 yearly changes in local tax codes, and be required to navigate a maze of arbitrary rules and exemptions. Among the hundreds of such rules in California’s 58 counties, 478 cities, and 35 special tax districts, for instance, carbonated water is taxed, but not mineral water. Fertilizer is taxed if used for a flower garden, but not for a vegetable garden.

These compliance burdens would cause many online startups to fail, while larger retailers would pass on the costs to consumers. For this reason, the U.S. Supreme Court determined in 1992 that businesses are only required to collect sales tax in states where they have a physical presence. For Internet-only companies, this places the burden on consumers to report and pay all applicable taxes. By exploiting a loophole to bypass this ruling, Skinner’s bill poses a dire threat to California’s entrepreneurs, bloggers, and small businesses.

According to AB 178, merely placing an advertisement on a Californian’s Web page satisfies the requirement for physical presence within the state. Revenue from advertisements allows countless Internet startups, media, and blogs to offer their content free of charge. According to Forrester Research, this popular practice could help generate more than $60 billion a year by 2012. If large firms suddenly refuse to advertise in California, the state’s high-tech economy could collapse. After New York began enforcing the “Amazon tax,” Utah-based terminated all advertising within the state, eliminating a critical source of revenue for 3,400 small businesses.

Companies such as do not aim to deprive states of sales-tax revenue, but they cannot reasonably comply with thousands of tax jurisdictions. To solve this dilemma, 22 states and 1,100 retailers have joined the Streamlined Sales Tax Project (SSTP), an effort to make state tax codes simple and uniform. California walked away from this effort in 2007. When faced with SSTP’s requirement that juice, water, and soda be taxed at the same rate, Board of Equalization member Bill Leonard quipped that “I don’t like giving up my sovereignty … to decide if we tax soda or not.

”The result is an inequitable system that punishes retailers for opening physical stores in California. While Skinner’s bill attempts to end the disparity between brick-and-mortar retailers such as Best Buy and Internet-only retailers such as, AB 178 creates more harm than good. Over the past 76 years, special interests have carved the sales-tax system into an indecipherable patchwork of exemptions, including everything from poultry litter to space vehicles. Instead of looking for ways to foist an imperfect tax code on a thriving new business model, why not reform the code to make it uniform, clear, and transparent?

In a global marketplace, Internet entrepreneurs will adjust strategies to compete as best they can for California’s large customer base. To avoid the daunting burdens posed by AB 178, these companies will withdraw critical advertising investment from the state. A simplified and consistent tax code, on the other hand, will ensure continued growth of a $200 billion e-commerce industry and protect California’s status as the nation’s high-tech leader.

Nothing contained in this blog is to be construed as necessarily reflecting the views of the Pacific Research Institute or as an attempt to thwart or aid the passage of any legislation.

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