Sales Tax: When ‘Animal Farm’ Meets the Metaphysical World of the Internet

Should the internet be a tax-free zone like the duty-free shops in international airport terminals? Does it make sense to subject the internet to a different set of laws than any other space?

These questions are central to the proposed Marketplace Fairness Act, which would empower states to collect sales tax from online sellers. Ahead of Congress, some states have become innovative in how they interpret the concept of "nexus" — i.e., the connection between a business and the state that legitimizes tax collection. These states have enacted what's become known as the "Amazon Tax," which increases the exposure of online merchants to the same sales taxes paid by brick-and-mortar businesses. So far, 21 states have enacted an Amazon-type law, expanding their reach to online retailers.

The debate boils down to commercial interests: physical businesses want online sellers to be subject to the same taxes they pay, and e-commerce companies want to keep their advantage. For businesses on the brick-and-mortar side, it's an "Animal Farm" situation where some businesses are more equal than others. For online sellers, the internet has been a loosely regulated frontier for so long and it seems unjust to suddenly change that. Still for others, the internet has been a loosely regulated frontier for too long, and it seems unjust to not change that.

Here's my take: taxation of online transactions is inevitable. Compared to the early days of e-commerce, there's now too much money flowing for states to ignore it, and there's no justification for it to be ignored. Assuming the internet is nothing more than a vehicle for communication and transferring information — and not a new metaphysical frontier — there's no reason for it to receive preferential tax treatment. From a business and compliance perspective, the evidence also suggests that online merchants will do just fine with this adaptation. The fact is that many online businesses collect taxes and manage a viable business.

"The Amazon Tax: Empirical Evidence from Amazon and Main Street Retailers," a study by three researchers at The Ohio State University, is sometimes touted as proof that the Amazon tax will severely damage companies like Amazon. The researchers found that households in California, New Jersey, Pennsylvania, Texas and Virginia reduced Amazon expenditures by 9.5 percent in response to the Amazon tax. However, this decrease was offset by a 2 percent increase in purchases at local brick-and-mortar retailers and a 19.8 percent increase in purchases with competing online retailers. For high-ticket items (over $300), the research found that consumers were even more likely to shift purchases from Amazon to other merchants.

The study concluded that taxing online businesses like Amazon "will lead to an increase in the online sales of national retailers while only modestly increasing local brick-and-mortar revenues." Brick-and-mortar businesses will still face disadvantages vis-à-vis online merchants who bear less overhead. There are several issues and takeaways from this study that need to be highlighted:

First, the researchers conducted this study in close proximity to the introduction of the Amazon Law, looking at a 12-week window in each state. Therefore, the data doesn't factor in the natural lag between the introduction of legislation and a company's response, such as adaptation to new price sensitivities. Indeed, Amazon is investing heavily in a supply chain network that will take some time to implement and will compensate for higher prices with faster delivery.

Second, the taxes didn't detract from online commerce in general. Rather, they only hurt Amazon. To the contrary, consumers remained online but shifted their focus to other e-commerce retailers (some of which might have collected sales taxes themselves). So what the study really managed to prove was that online consumers are price sensitive. Ease of search means that store loyalty gives way to price preference.

With this in mind, let's return to the questions posed at the outset of this review: Should the internet receive special treatment? Should it be a duty-free zone? Should we subject it to different rules, laws or tax regulations?

While Amazon might have seen a temporary downward tick in its sales, the company has the ability to adapt to this change. Presumably, Amazon will be able to change its pricing models and terms of sale to recoup the lost sales. Overall, e-commerce wan't hurt by Amazon taxes.

As long as online retailers are managing their business in the real, physical world, benefiting from all those features that are funded by taxes (e.g., roads, governments, even telephone wires and cables necessary to transmit the bits of information which constitutes the internet), there's no reason why they should be relieved from their tax obligation.

In Quill Corp. v. North Dakota, the Supreme Court concluded that it would be too much of a burden and too expensive to require small businesses to track the rates and rules of 10,000 taxing jurisdictions. However, that ruling was made in 1992. Since then, technological innovation has produced easy-to-use, inexpensive, highly credible solutions to address this burden. Those who are quoting the undue burden rationale as a basis for their opposition to imposing sales taxes are either still living in 1992 or they're trying to benefit unfairly from confusion surrounding the rapid growth of the internet. Online merchants can comply with sales tax just as easily as brick-and-mortar businesses.

It's time that online and physical retailers be treated as equals. It's time that we stop pampering the internet like a toddler. The internet is a mature business environment; let's give it the respect it's due.

Jonathan Barsade is the CEO of Exactor, a provider of automated systems to calculate sales and use taxes for online retailers.