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.
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.