Politically Direct Summer 2009: Nexus Tax: Bad Policy, Bad For Consumers, Bad For California

By Tammy Cota

Interim Executive Director, Internet Alliance

July 28, 2009 — California state lawmakers, apparently desperate to fix massive budget deficits, passed a controversial tax law that would require many online retailers to begin collecting sales taxes on purchases shipped to the state, even when they have no operations or employees working there. Framed as a positive development by tax advocates, this law would have had disastrous ramifications for California businesses. Fortunately for those businesses, Governor Arnold Schwarzenegger vetoed the legislation.

On June 30, Schwarzenegger issued a veto message, stating: “After passing the largest tax increase in California history, it makes absolutely no sense to go back to the taxpayers to solve the current shortfall – that’s why yesterday I vetoed the majority vote tax increase passed by the legislature. With unemployment at an all-time high, we should be doing everything we can to - keep jobs and create jobs - in California. That is why my Administration immediately contacted Overstock.com when we learned of this news and, I am pleased to announce, Overstock.com has reversed its decision and will continue to do business with affiliates here in California. I will continue to fight to keep jobs and businesses in California.”

The appeal of this type of legislation for California lawmakers was the promise of additional revenue. Local booksellers were behind much of the push for taxation. They were very aggressive in their effort to persuade legislators that local “mom-and-pop” businesses are being shut down because online merchants are not charging sales tax. According to recent statistics, however, the 257 booksellers located in California only bring the state about $17 million in state income tax.

There are 25,000 affiliate marketers in California who derive about 80 percent of their income from out-of-state companies. These affiliates earn approximately $1.32 billon a year. That translates to $123 million in state income tax — revenue that could be in jeopardy if companies such as Amazon and Overstock were to terminate their affiliate relationships.

This reduced revenue could have meant 75,000 lost jobs. California currently has an 11 percent unemployment rate, which, as Governor Schwarzenegger mentioned, is an all-time high. The latest Anderson Forecast from the University of California has predicted that the state’s unemployment rate could reach 12.1 percent in 2010.

The US Supreme Court [see Quill Corp. v. North Dakota, 504 US 298 (1992)] has made clear that physical presence, or nexus, is necessary for states to compel companies to serve as tax collectors. Therefore, these attempts to redefine nexus are not only poor tax policy, but also unconstitutional. This type of legislation would require remote sellers with no physical presence in these states to collect and remit tax based on advertising dollars spent there. Remote sellers have only an advertising relationship, which clearly does not constitute physical presence.

Ultimately, California businesses and taxpayers would have been the ones that lost out, as these affiliates would have moved their marketing dollars elsewhere. Additionally, if this tax had passed, taxpayers would have been the ones to incur the cost of defending this unconstitutional law, as the courts would have been asked to resolve the nexus issue.

Over the past 10 years, California expenditures have far outpaced the rate of inflation, and continue to do so. The source of the current budget problems is that state revenues, heavily dependent in good years on income taxes, have become severely depleted during the economic crisis, and the nexus tax would only deplete it further.

The Internet Alliance realizes that California is still facing an unprecedented fiscal crisis. However, creating this type of tax instead of cutting state spending would have only harmed the economy at the worst possible time.

The Internet alliance believes that legislators should be working on measures to strengthen Internet commerce, rather than placing undue burdens that would weigh it down in return for the theoretical gain of a projected retail taxation opportunity.

About Tammy Cota and the Internet Alliance:

Tammy Cota is interim executive director of the Internet Alliance (IA), which is a leading advocacy organization of policy professionals representing the Internet industry in all 50 states. The IA’s mission is to promote confidence and trust in the Internet so it can reach its potential as the most dynamic market medium of this century.

The IA advocates for the Internet industry and e-commerce on issues important to consumers and businesses. The IA takes a positive and proactive approach to the policy dialogue by developing consistent and strategic core messages in several policy areas affecting consumers and businesses’ bottom line.

# # #