Amazon Gets Ready for Sales Taxes

It was a good run, and a long one: After nearly two decades of largely tax-free e-commerce, a growing number of states are forcing online retailers to collect sales taxes. Brick-and-mortar retailers will regain some of their competitive edge, but paradoxically Amazon is likely to benefit from the change. 

The past several weeks have seen indications that not only will Amazon and others have to start paying taxes, the company is taking bold steps to prepare for it. New Jersey governor Chris Christie joined other Republican governors in working out deals to start pushing for online taxes in exchange for Amazon distribution centers. But Amazon has countered by pushing into new initiatives, such as laying the groundwork for same-day deliveries, as well as a smartphone that could compete with the iPhone and Android phones.

The Era of Tax-Free E-Commerce

Since the earliest e-tailers hung out their URLs in the mid-'90s, online stores have avoided sales taxes in most states. Many established operations and distribution centers in states with little or no sales taxes. In 1998, Congress passed a three-year moratorium on e-commerce taxes to nurture the fledgling industry. Later on, companies relied on a 1992 Supreme Court ruling that companies could avoid collecting taxes if they had no physical presence in a state.

State governors have long tried to impose online taxes, including an effort in 1999 to declare credit-card companies a collection intermediary. But it was only around 2005 when the tide began to change. A court ordered Borders to pay taxes for its online sales in states where it had bookstores.

Others managed to avoid taxes – notably eBay, Overstock.com and above all Amazon, which aggressively fought state tax campaigns by backing ballot initiatives, moving distribution centers or canceling affiliate programs in states that pushed for online taxes.

Surrender to the Inevitable

But even Amazon seems resigned to the inevitability of sales taxes. The company collects taxes in New York, Texas and several other states and will begin collecting in several more, including California this September. And, as The Wall Street Journal reported today, the largest online retailer is making deals with cash-strapped states like New Jersey and Virginia to delay tax collection in exchange for new Amazon distribution facilities that could bring full-time and temporary jobs.

The Journal noted that many governors who are supporting online taxes are Republicans, a party loathe to raising taxes, but the push to collect e-commerce tax is less a tax increase than the closing of a large and long-standing tax loophole. Early on, that loophole helped Amazon and others grow into the giant, profitable companies they are today. Over time, however, many independent retailers couldn't compete with what was – as far as the consumer was concerned – a de facto discount as big as 11% in some states.

Amazon's Preparations

But the valiant effort of Amazon and others to avoid the inevitable bought the e-tailing industry time to prepare for online sales taxes. And no company seems better prepared than Amazon. As the Financial Times and Slate argued recently, a tax-collecting Amazon could be an even-bigger threat to brick-and-mortar shops because more distribution facilities mean Amazon could deliver some orders in a matter of hours.

But same-day delivery is but one piece – albeit an important one – in Amazon's preparation for the end of the online tax break. The Kindle e-reader turned the company into a thriving e-book seller: Adding a 10% sales tax to a $9.99 Kindle book still leaves the e-book cheaper than a print version. And the company's Prime subscription service eliminates two-day shipping costs, which tend to dwarf most sales tax rates.

What's more, capitulating to tax collection in more states will free Amazon to make many purchases it never could before. Netflix has long been considered an ideal acquisition target for Amazon, but Netflix maintains distribution centers in many states that charge online sales taxes.

Impact on E-Tailers

The end of the online tax break isn't bad for Amazon, it's mixed – and Amazon is ready to make the best of it. It's the smaller operations that are going to be hurt. Sites like Overstock.com, and also the many small retailers that sell through eBay's marketplace. eBay itself may not be hurt as much. The company has been increasingly relying on PayPal for growth, and PayPal is well positioned for mobile e-commerce.

In the end, leveling the tax-law playing field between online and brick-and-mortar stores will bring a much-needed lifeline to mom-and-pop retailers who compete with Amazon. But it's not going to hurt Amazon. It's more likely to further consolidate Amazon's control of the e-commerce world as consumers gravitate toward its Kindle books, its Prime discounts and its planned same-day delivery service.