Will Amazon Really Benefit From an Internet Sales Tax?

On Monday, the U.S. Senate passed the Marketplace Fairness Act, which would give states the ability to require Internet retailers with more than $1 million in out-of-state sales to collect sales tax. The bill still needs to pass the Republican-controlled House to become law, which could present a significant hurdle, but Monday's 69-27 vote was still a major step forward for this legislation. The bill has been vocally opposed by major online retailers, most notably eBay (NASDAQ: EBAY  ) and Overstock.com (NASDAQ: OSTK  ) , along with many small businesses that operate online. It has received equally vocal support from brick-and-mortar giants like Wal-Mart (NYSE: WMT  ) and Best Buy (NYSE: BBY  ) , and small businesses that do not have an Internet presence.

Curiously, e-commerce giant Amazon.com (NASDAQ: AMZN  ) has expressed support for the bill, even though it could eventually be required to collect sales tax in dozens of states where it does not already do so. This has led some analysts to argue that collecting sales tax is actually good for Amazon, because it will allow the company to build fulfillment warehouses anywhere in the U.S. However, this argument does not hold water. On a net basis, the Marketplace Fairness Act will probably hurt Amazon.

The great debate
Physical retailers' support for the bill is not very surprising. Companies like Best Buy have long complained that the government is giving an unfair 5% to 10% cost advantage to Internet retailers, which has helped to drive the "showrooming" trend, particularly for expensive items. Online small businesses (and their champions, such as eBay) counter that it is too complicated to collect tax in every U.S. jurisdiction and that they would have to downsize if the bill becomes law. Some online retailers also argue that as out-of-state businesses, they do not benefit from the services that are supported by sales taxes, whereas local businesses do receive those benefits.

In the case of Amazon, bulls argue that the company's success has little or nothing to do with sales tax collection, or the lack thereof. Instead, they point to Amazon's simple user interface, strong customer service reputation, and price leadership as the factors responsible for its success. Some people go further and argue that the negative impact to Amazon of collecting sales taxes would be far outweighed by the benefits of building more warehouses, which could reduce shipping costs and delivery times. This perspective has a strong element of truth, but at the margin it is fairly clear that Amazon has profited from not collecting sales taxes.

The tax effect
First, Amazon already has the ability to build warehouses wherever it wants: The company would just need to start collecting sales taxes in those states. Instead, Amazon has expanded its warehouse footprint very deliberately, building multiple warehouses in some states while avoiding others entirely (in order to avoid collecting sales taxes there). Furthermore, Amazon has usually dragged its feet when states have tried to force it to collect sales tax. Often, it has built warehouses in conjunction with agreements to temporarily postpone collecting sales tax! This behavior strongly suggests that Amazon's management believes the cost of collecting sales tax outweighs the benefit of expanding Amazon's warehouse footprint.

Amazon's recent sales trends also cast doubt on the proposition that sales-tax avoidance is not important for most Amazon customers. Amazon began collecting sales tax in Texas, Pennsylvania, and California in third-quarter 2012. Sales growth in North America immediately dropped off, from 36% in second-quarter 2012 and 35% in third-quarter 2012 to 30% in fourth-quarter 2012 and 26% in first-quarter 2013. Moreover, this may understate the drop-off in Amazon's retail sales growth rate, because Amazon reports all the revenue for its rapidly growing cloud services business -- Amazon Web Services -- in the North America segment.

Foolish conclusion
The correlation between Amazon's increased sales tax collection and the recent slowdown in sales growth does not definitively prove causation; other factors may have played a role. However, this evidence strongly suggests that consumers will cut back on purchases at Amazon, eBay, and other online-only retailers in favor of Wal-Mart, Best Buy, and local businesses if the sales tax playing field is leveled.

The only potential benefit for Amazon is that smaller online retailers would have a harder time complying with the law, and some might be unable to compete with Amazon. Even that benefit is offset to the extent that many of these smaller online retailers have been contributing to the growth of Amazon's highly profitable third-party "marketplace" program. In combination with Amazon's stretched valuation, the risks associated with the Marketplace Fairness Act provide a good reason for investors to remain wary of Amazon stock.

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Read/Post Comments (8) | Recommend This Article (3)

Comments from our Foolish Readers

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  • Report this Comment On May 08, 2013, at 10:46 PM, MFMotleyStool wrote:

    There's no way this is helpful to Amazon. They know there own stock is not based on any real fundaments other than maybe revenue growth so now they change their tune in order to say it's good for them when this gets passed so here's another reason to have the HFT's bid up the stock.

    Please. The stock corrected a little after earnings and would correct a lot more if not for the bigger fool and HFT bots bidding it up on mild volume.

  • Report this Comment On May 09, 2013, at 6:28 PM, cmt2 wrote:

    Wow. I continue to be amazed that no commentators remember or choose to report on the Amazon/California history.

    A couple of years ago, California was set to force Amazon to collect local taxes, and Amazon said they had no physical presence, and California said what about all your affiliates and Amazon dumped them, and the public got upset.

    So a deal got cut: Amazon would start collecting tax, but only after a year, and Amazon would not oppose (not quite the same as support) a federal law.

    Meanwhile, with the physical presence rule no longer relevant, Amazon reinstated all its local vendors (a very large number), and also started building giant distribution centers near LA and SF, cutting their shipping time in half.

    Bottom line: in exchange for putting off the inevitable by a year, Amazon was able to cut its shipping time to two huge markets in half. Seems pretty savvy to me.

  • Report this Comment On May 09, 2013, at 8:26 PM, kinosternon wrote:

    It will absolutely benefit Amazon! They can afford the expense. It will kill a lot of their competition--the small mom-and-pop online retailers. They will be laying off employees or closing up as many of them can't afford the added expense. It'll be a sad day for American entrepreneurship if this passes.

  • Report this Comment On May 09, 2013, at 9:15 PM, RobertC314 wrote:

    It's also interesting to note that technically people who buy from out of state are required to pay a "use tax" in the state they ship to which is equivalent to a sales tax. The only difference is that this is the responsibility of the consumer and is universally not paid (in fact, many states lack the ability to collect it even if you try to pay it).

  • Report this Comment On May 09, 2013, at 11:02 PM, harmonyjoe wrote:

    Unless Amazon Mgm't are idiots and their success thus far makes that assessment unlikely, I very much doubt they would support the Internet Sales Tax Bill if it couldn't be worked around. What incentive could they possibly have to do so if they couldn't make it work?

  • Report this Comment On May 10, 2013, at 8:19 AM, sibtrag wrote:

    I wonder if there is some possible benefit to Amazon.

    First off, many of those small online retailers may become part of Amazon's marketplace program to eliminate the hassle of calculating & collecting sales tax.

    The marketplace program is just one example of how Amazon leverages the infrastructure they've built up to support their own product line (in this case they provide storefront, shopping cart, etc while the small business does inventory & fulfillment). They also lease unused cloud computation power. Perhaps they could make an offering where Amazon just computes, collects & distributes sales taxes for online businesses that maintain their own storefront & fulfillment.

  • Report this Comment On May 10, 2013, at 8:22 AM, sibtrag wrote:

    Now that I think of it, Paypal would be another company which could benefit in this way. They could add a feature to their payment service which would calculate the applicable sales tax on sales through their payment network. Instead of turning it over to the retailer, Paypal could retain the sales tax (earning the float) and handle the payments to the various jurisdictions.

  • Report this Comment On May 10, 2013, at 8:40 AM, ETFsRule wrote:

    kinosternon has it right. Amazon is in a much better position to handle these extra costs than their competitors. It could be a net benefit for them.

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