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Can states force e-commerce companies to collect sales tax? That’s the question at the heart of South Dakota v. Wayfair, a pivotal legal case argued before the United States Supreme Court on Tuesday. It’s one the National Conference of State Legislatures has called the “tax case of the millennium,” and one that could have enormous impact on the ongoing competitive war waged between online retailers like Amazon and more traditional brick-and-mortar stores.

A little background: Since the late 1960s, states have been allowed to collect sales tax only from businesses with a physical presence in their state. That’s thanks to the way that SCOTUS interpreted the Commerce Clause in the 1967 case Nat’l Bellas Hess, Inc. v. Dep’t of Rev. of the St. of Ill, when it ruled that Illinois could not require a Missouri mail-order company to collect tax on goods shipped and sold into the state. The seller, the Court reasoned, didn’t maintain any offices or a warehouse in the state, or have any employees or real estate, and so shouldn’t be taxed as though it did. This interpretation was upheld most recently in the 1992 case Quill v. North Dakota, which reaffirmed that out-of-state mail-order companies don’t have to pay sales tax.

Why did Amazon ended up in Seattle in the first place? The location made it easier to avoid sales taxes.
But things have changed since 1992. E-commerce is now a rapidly growing sector, one that’s changing our sense of what it means to shop, and at the same time encroaching rapidly on more traditional business models. Some have argued the tax-free status of online purchases isn’t just a competitive advantage—it’s bad for government. While some companies have begun collecting sales tax voluntarily, many transactions continue to go untaxed—a situation states are eager to remedy as e-commerce’s footprint grows. According to a report from the Government Accountability Office (GAO), U.S. states could have collected $13 billion more in tax from out-of-state purchases made online.

Which is where South Dakota v. Wayfair comes in. In 2016, South Dakota enacted a law requiring any sellers of “tangible personal property” to collect sales tax and remit it to the state. (The law only applied to sellers who passed a certain threshold: South Dakota sales of over $100,000—or 200 separate transactions—a year.) Soon after the bill was signed into law, the state issued written notices to e-retailers it believed to be doing significant sales, urging them to register for South Dakota sales tax licenses. When four companies held out—Wayfair, a budget home decor company; Overstock.com, the online surplus store; NewEgg, a home electronics e-retailer; and industrial equipment supplier Systemax—South Dakota appealed to a state court, asking that they be compelled to comply. Systemax did so voluntarily. The other three companies argued that the law was unconstitutional under Quill, and ultimately the state court agreed and dismissed the case.

It’s South Dakota’s appeal that brought the matter back to the Supreme Court.

Some have argued the tax-free status of online purchases isn’t just a competitive advantage—it’s bad for government.
Like other states that have tried to enact similar measures, South Dakota argued that Quill might have made sense in 1992, but today drastically erodes the tax base, making it difficult for the government to function. “The harm from the loss of revenue is especially serious in South Dakota because the state has no income tax, and sales and use tax revenues are essential in funding state and local services,” the state’s legislature wrote, in the text of the 2016 law challenged by Wayfair.

Others have argued that e-commerce companies wield their ability to avoid sales taxes as a competitive weapon, undercutting brick-and-mortar businesses and shutting down local Main Streets. In fact, one of the biggest names in online retail has been candid about the how very useful this strategy is: Amazon CEO Jeff Bezos.

With the furor building over Amazon’s search for a new location for its second corporate headquarters—and with local and state governments falling all over themselves to lure the company with generous subsidies—people forget why Amazon ended up in Seattle in the first place. The answer’s simple: The location made it easier to avoid sales taxes.

Bezos originally hoped to find a way to game the system and avoid sales taxes altogether. In the early days, he told Fast Company in a 1996 interview, he looked into “whether we could set up Amazon.com on an Indian reservation near San Francisco. This way we could have access to talent without all the tax consequences.” It didn’t work out. “Unfortunately, the government thought of that first,” he said.

Early signs suggest that SCOTUS will decide to uphold the constitutionality of Quill.
The next best option was what Bezos called the “small-state strategy”—finding a conveniently located smaller state to reside in, so that state taxes could still be evaded for orders shipped to larger, more populous states.

“It had to be a small state,” he told Fast Company. “In the mail-order business, you have to charge sales tax to customers who live in any state where you have a business presence. It made no sense for us to be in California or New York.”

In other words, sales tax avoidance is in e-commerce’s very DNA. And Amazon’s shrewd, knowing reliance on the Quill decision allowed to it to undercut traditional competitors for years. As of April 1, Amazon voluntarily collects sales tax in all states that have one, but only on goods it ships itself. It doesn’t collect sales tax on goods shipped through third-party companies, which amounted to 50 percent of its sales in 2016.

Will South Dakota v. Wayfair level the playing field, creating a new era of parity between e-commerce and brick-and-mortar sales? It’s looking less likely. The Court heard arguments on Tuesday and, while a final ruling isn’t expected until summer, early signs suggest that SCOTUS will decide to uphold the constitutionality of Quill. Reuters reports that the Court “appeared hesitant” to let states compel e-commerce companies to collect sales taxes. Justice Elena Kagan suggested that Congress would have better luck “crafting compromises and trying to figure out how to balance the wide range of interests involved here.”

We’ll be watching.

TL;DR: The Supreme Court heard arguments on Tuesday regarding whether states can force online retailers to collect sales tax. It’s decision that will have a major impact on how we buy online and who we buy from.

Joe Fassler bio

Joe Fassler

Joe Fassler is The New Food Economy's features editor. His food safety and public health reporting has been a finalist for the James Beard Foundation Award in Journalism. Follow him @joefassler.