and the States: Untapped Revenue Streams: A Fiscal Alert from the SLC

South Carolina Update on SLC and the States Fiscal Alert (June 8, 2011)

On June 8, 2011, South Carolina Governor Nikki Haley allowed SB 36 to become law without her signature. The legislation grants Amazon a five-year exemption on collecting sales taxes on online purchases made by South Carolina residents. In return, Amazon will spend at least $125 million in capital investments building a distribution center in Cayce (Lexington County) and create at least 2,000 jobs within three years. The Amazon tax break was initially rejected (71-47) by the South Carolina House of Representatives back in April; however, after Amazon
made further commitments to the deal, many House members changed their positions and voted 97-20 in favor of the tax exemption along with the prior approval by the South Carolina Senate.

On April 27, 2011, the South Carolina House of Representatives, by a vote of 71-47, defeated an amendment that would have provided a five-year sales tax exemption to in exchange for the company building a distribution center in Lexington County, in the central part of the state. While this vote resulted in Amazon canceling plans to proceed with an operation in South Carolina, it also raised to the forefront a burning issue confronting state policymakers: how should states react to the exponential growth in e-commerce transactions that largely occur without the collection of invaluable sales taxes? As states struggle to deal with the sharp drop-off in revenues caused by the Great Recession, the panoply of issues related to collecting sales taxes on e-commerce transactions continues to roil state policymakers across the  country.
The federal Census Bureau report in late March 2011 indicating that overall state and local government tax revenues expanded by 1.6 percent to $378.3 billion during the final quarter of 2010 compared to the same period in 2009 was very welcome news. Despite this revenue
increase, state and local governments continue to struggle mightily from the rigors of the Great Recession, the worst fiscal downturn in more than eight decades. In fact, current revenue levels in states remain far below the levels reached before the onset of the Great Recession some three years ago and states continue to face a yawning chasm between revenues and   expenditures. According to the Washington, D.C.-based Center on Budget and Policy Priorities, the cumulative budget shortfalls in states, actual and estimated, for the four-year period of fiscal years 2009 through 2012 will total nearly $550 billion, a monumental number by any standards. While 44 states are anticipating budget shortfalls in fiscal year 2012, reaching a staggering $112 billion cumulatively, two SLC states (Arkansas and West Virginia) rank among the six states not forecasting shortfalls.
Beyond the immediacy of grappling with current revenue shortfalls, states also face the continuing challenge of an eroding tax base related to the exponential growth in e-commerce transactions. This is because a 1992 U.S. Supreme Court ruling (Quill Corporation v. North
Dakota) held that online retailers only are required to collect sales tax on a transaction if they have a physical presence in a the state of the purchasing customer. As a result, states are largely unable to apply sales tax to a burgeoning sector of the economy, i.e., e-commerce transactions, a sector that has experienced stratospheric growth in the last decade. In fact, the U.S. Department of Commerce reported that total e-commerce sales in 2010 in the United States skyrocketed to an estimated $165.4 billion, an increase of 14.8 percent from 2009, whereas Forrester Research, the technology and market research company, estimates that by 2014, e-commerce sales could expand to reach nearly $250 billion. Even as a proportion of total sales, e-commerce transactions have seen steady growth in 2010, accounting for 4.2 percent of total sales in contrast to the first quarter of 2001, when they amounted to a mere 1.1 percent, a stark demonstration of the growing clout of e-commerce. To a large extent, these e-commerce transactions occurred without online retailers collecting sales taxes on behalf of state and local governments. In fact, the University of Tennessee’s Center for Business and Economic Research (CBER) estimates that by 2012 states will lose between $11.4 billion and $12.65 billion from untaxed online sales.
The adjacent table presents projections made by the University of Tennessee’s Center for Business and Economic Research in April 2009 regarding state and local government sales tax revenue losses from e-commerce transactions. CBER has been studying this issue for nearly 15 years and, in this most recent study, estimated the state and local government sales tax losses arising from e-commerce for 46 states and the District of Columbia using both a baseline forecast and an optimistic forecast for e-commerce growth. According to the baseline case, CBER estimated that annual national state and local sales tax losses on e-commerce will grow to $11.4 billion by 2012 for a six-year total loss of $52 billion; for the more optimistic growth case scenario, CBER estimated losses to reach $12.65 billion by 2012 and an  aggregate loss of $56.3 billion.
Under the baseline estimates carried out by CBER, the losses to the SLC states remain  substantial. For instance, for the six-year period 2007-2012, Florida is projected to lose $3.7 billion as a result of not collecting sales taxes on e-commerce transactions, while Texas’ losses are projected to reach $4.0 billion for the same period. Even smaller states like Mississippi ($616.5 million) and South Carolina ($569.3 million) are estimated to experience significant losses. In Tennessee, a state that does not have a personal income tax, the estimated $1.9 billion lost in potential sales tax revenues over the six-year review period remains noteworthy. Given the fact that a permanent solution to the quandary confronting states with regard to applying sales tax on both e-commerce and regular purchases has to involve federal legislation, a number of state fiscal experts bemoan the fact that Congressional inertia or inaction has resulted in delaying much needed revenue to states for nearly two decades.
Notwithstanding the constraints imposed by the lack of federal action on this issue, a number of states have coalesced to devise a solution to the burgeoning e-commerce transactions occurring within their borders. Specifically, in the fall of 1999, a number of states formed the Streamlined Sales and Use Tax Agreement (SSTA). The Agreement seeks to simplify the rules that govern the collection of sales taxes in more than 8,000 different jurisdictions across the country. Specifically, the Agreement intends to minimize the costs and administrative burdens placed on retailers that collect sales taxes, particularly retailers operating in multiple states. In essence, the Agreement works toward ensuring that the administration of the sales tax in one state is similar to any other state given that it is applied on certain goods in one state while being exempt in another state. In addition, while the Agreement encourages “remote sellers” selling over the Internet and by mail order to collect sales taxes from customers living in states that have enacted conforming legislation, it also levels the playing field so that local ‘bricks-and-mortar’ stores and online and mail order retailers operate under the same rules. As of January 1, 2011, 24 states had enacted conforming legislation complying with the Agreement, though a number of the larger states (California, Florida, Illinois, New York, Pennsylvania and Texas) had not signed on as full member states. It should be noted that conforming legislation had been enacted in some of these larger states.
In terms of assessing the major players in the tens of billions of dollar e-commerce trade, vaults to the top., the multinational e-commerce company founded in 1994 by Jeff Bezos (the site went online in 1995), is the largest online retailer in the United States and, for that reason alone, garners the most attention in the ongoing de bate with states over sales tax collections. In fact, as of January 2010, Amazon’s Internet sales revenue was nearly three times the amount of its nearest rival, Staples, Inc. It is estimated that about $1 billion of the amount states currently lose from e-commerce transactions is related to  transactions on Amazon.
For a number of years now, online retailers like Amazon (with net sales that rose 40 percent to more than $34 billion in 2010), and diamond Internet retailer Blue Nile, have resisted collecting sales taxes on behalf of state and local governments on the e-commercet ransactions occurring on their websites. The primary force behind this disinclination involves the fact that applying a sales tax effectively raises the price a retailer may charge, a move that would make the online retailer less competitive vis-à-vis a similar purchase made at a bricks-and-mortar store. Furthermore, online retailers contend that they are not required to collect sales taxes for the following reasons: (1) they usually do not have a physical presence, or  nexus, in the state; (2) they are not always directly involved in the transaction since they often deploy local affiliates, i.e., partner sites, local businesses, blogs or non-profits, that earn  commissions by advertising or linking to an online retailer’s products; and (3) the warehouses processing the e-commerce purchases are owned by subsidiaries and not directly by the online retailer. It should be noted that Amazon does collect sales taxes in five states:  Washington, where it is based; Kansas and North Dakota, where it has call centers; Kentucky, where it processes returns; and New York, due to legislation passed in 2008, though it is protesting this law in court. Similarly,, another major web-based retailer, collects sales taxes from customers in its home state of Utah.
The extreme fiscal stress currently faced by states and the dire need for revenue has  prompted a number of states to either enact or propose legislation requiring these online
retailers to collect sales taxes on e-commerce transactions. In April 2011, Governor Mike Beebe of Arkansas signed Senate Bill 738 into law, making his state the latest to require Internet retailers like Amazon and Overstock to collect sales tax on e-commerce purchases if they do business with Arkansas-based affiliate websites. Specifically, the Arkansas law   requires the online retailers to collect sales taxes if they generate more than $10,000 a year in sales from Arkansas residents on sales originating on local affiliate websites. Governor Beebe envisions the legislation as a mechanism to generate immediate revenue by increasing sales tax collections and indicated that “We have a lot of local businesses in Arkansas, both small and large companies, that collect sales tax and we are trying to level the playing field.”
Previously, in March 2011, Illinois enacted legislation requiring online retailers that work with affiliates in the state to collect sales taxes on e-commerce purchases by residents. Officials in Illinois maintain that the state loses an estimated $153 million annually in sales tax revenue
as a result of e-commerce transactions. Arkansas and Illinois’ laws mirror legislation already in place in Colorado, New York, North Carolina and Rhode Island, while lawmakers in Arizona, California, Connecticut, Hawaii, Massachusetts, Minnesota, Missouri, Tennessee, Texas and Vermont also have proposed similar legislation. California, according to the state’s Board of Equalization (the state’s tax agency), lost $1.15 billion in sales tax revenue in 2010 from  e-commerce and catalog sales, an amount that would more than cover the planned cuts for
the University of California system or programs for the state’s developmentally disabled.
The strategy adopted by states to tap local affiliates to collect sales taxes on online  transactions through an out-ofstate-online retailer’s website takes the form of so-called
‘click through’ laws. Local affiliates are offered a referral fee by the out-of-state-online retailer for every purchase that originates at the local affiliate’s site and then proceeds to the online retailer’s site. The ‘click through’ provision in these state laws designated that the local affiliate represented a sufficient physical presence, a designation that required the online retailer to collect sales taxes on the purchase. In response to the ‘click through’ legislation in states requiring affiliates to collect sales taxes, Amazon terminated its affiliate programs in Colorado, North Carolina and Rhode Island and has indicated that it will do so in Illinois too. Similarly in Arkansas, by April 5, 2011, sent notices to all of its Arkansas affiliates  indicating that it will no longer do business with them as of May 1, 2011, unless they relocate to another state without a similar affiliate tax law.
In order to explore some of the nuances of the dispute between Amazon and the states over requiring local affiliates to collect sales taxes for online purchases, a review of the exchange with North Carolina is appropriate. In the summer of 2009, the North Carolina General Assembly enacted legislation that stated the following: “a remote retailer who enters into a ‘click-through’ contractual agreement with a North Carolina resident is soliciting business in this State for purposes of requiring a remote retailer to collect sales tax.” As a result of this August 2009 law, Amazon immediately ended its program for marketing affiliates in North Carolina. The North Carolina Department of Revenue then initiated a sales and use tax audit of Amazon, which resulted in the company turning over details on more than 50 million product sales to the Department to assess sales and use tax obligations. Importantly, Amazon—citing the privacy rights of its customers—did not turn over customer names. As the Department worked on securing a court order that would require Amazon to provide that information, Amazon filed a suit in federal court, in its home state of Washington, to thwart North Carolina’s efforts. In June 2010, the American Civil Liberties Union (ACLU) joined Amazon’s lawsuit against North  Carolina, reiterating the argument that the state’s request for information that identified residents by name would violate their right to privacy.
In October 2010, the federal judge hearing the case concurredwith Amazon and the ACLU’s contention regarding the privacy factor and, in January 2011, the state decided not to appeal this federal judge’s decision. In February 2011, the state settled the privacy lawsuit with Amazon and the ACLU and, as part of future requests for information, it agreed to add the following caveat: “This information request does not request the names, titles, or other  identifying information from which names and titles can be derived of the books, movies, music or other expressive items sold.” It is not clear at this time whether Amazon intends to comply with the state’s request for customer names along with generic product descriptions, which would allow North Carolina tax officials to tax Amazon customers for online purchases made as far back as 2003. The state, while maintaining that its intentions did not involve an attempt to obtain information on the specific online purchases made by residents, noted that “the lawsuit on this particular issue could have been avoided altogether if not for the aggressive stance Amazon took to avoid compliance with North Carolina’s tax laws. There would never have been an issue of customer privacy if Amazon would simply collect the North Carolina sale tax that others already do.”
In addition to enacting laws requiring local affiliates to collect sales taxes on online purchases, states also have begun forwarding tax bills to Amazon for uncollected sales taxes. For instance, in September 2010, based on an audit of e-commerce transactions within the state, Texas Comptroller Susan Combs sent the company a bill for $269 million for uncollected sales taxes (including interest and penalties) for the period December 2005 to December 2009.  Comptroller Combs maintains that, “If you have a presence in the state of Texas, you are required to pay sales taxes, just like any other business that has a presence in the state.” In response, Amazon maintains that its Irving, Texas, location does not represent a company storefront—since it is owned by a subsidiary—and that it does not constitute the kind of physical presence the state’s sales tax laws require. Comptroller Combs’ office indicated that Texas loses an estimated $600 million in e-commerce sales taxes every year. In response to the tax bill from Texas, Amazon announced the closure of its Irving distribution center (one it had operated since 2005) and desire to relocate to another state with a more hospitable tax environment. While the closing of its Texas operation will see the evaporation of 119 jobs, Amazon indicated that, prior to the dispute with Comptroller Combs, it had planned a  significant expansion of its Irving distribution center—also called a fulfillment center—with “more than 1,000 new jobs and tens of millions of investment dollars to the state.”
Soon after Amazon’s decision to close its distribution center in Texas, the company announced that it was making preliminary inquiries into opening a distribution center in either South Carolina and/or Tennessee. In terms of the specifics of the South Carolina project, the proposed Amazon distribution center near Cayce in Lexington County would be a $100 million project (including a $60 million-a-year payroll by 2013 and $40 million building) projected to employ 1,249 full time employees by 2013 and provide up to 2,500 part-time jobs. In exchange, Amazon requested a tax incentive that would exempt the company from collecting sales tax on goods shipped to South Carolina residents. In December 2010, state economic development officials working for then-Governor Mark Sanford agreed to seek the tax break as part of a deal that resulted in Amazon announcing that it would open the center in South Carolina. However, current Governor Nikki Haley, in early April 2011, announced that she did not support Amazon’s quest to secure an exemption from collecting sales taxes on goods that it sells within the state. However, the governor did indicate that if the South Carolina General Assembly did approve such an exemption, she would not veto the legislation.
In turn, South Carolina Speaker Bobby Harrell indicated that, “We need the governor or the folks in Lexington County to tell us what they want us to do.” Other lawmakers also expressed the view that they need the governor to take a clear position on the tax break and described the governor’s position as “crucial.” In turn, Amazon raised the stakes in the entire debate by noting that loss of the tax break could cause them to cancel the entire distribution center  project. By the second week of April, South Carolina lawmakers, particularly those representing Lexington County, were pushing for a five-year sales tax exemption for Amazon. Yet,  opponents of this sales tax exemption were vocal too, and clinching it was termed “an uphill battle” by Representative Kenny Bingham, Majority Leader in the South Carolina House of Representatives, whose district includes the potential Amazon site. On April 14, 2011, as its legislative allies raced to deliver the sales tax exemption, Amazon indicated that it had placed a freeze on 11 management positions that previously had been advertised for the South Carolina distribution center. A few days later on April 19, 2011, the South Carolina Senate Finance Committee, in a 15 to 5 vote, agreed to send a bill to the floor for further debate that would leave up to consumers to pay sales taxes for online purchases made from Amazon. Finally, on April 27, 2011, after the South Carolina House of Representatives rejected legislation granting the tax break to Amazon in a 71-47 vote, an Amazon official indicated that the company had “canceled $52 million in procurement contracts and removed all South  Carolina fulfillment center job postings” from its website. While other measures proposing the tax break remain alive in the South Carolina House, legislative observers note that the lopsided nature of the initial vote made it unlikely that any further measures will be considered.
While this debate was ongoing in South Carolina, in early April 2011, the outside walls of a proposed Amazon distribution center began to take shape in Chattanooga, Tennessee. The company also has plans to construct a second distribution site at another southeast Tennessee location in nearby Bradley County. In total, Amazon is expected to invest about $139 million constructing these two sites and eventually hire more than 1,400 full-time workers and more than 2,000 part-time workers. The 79.1-acre Amazon Chattanooga distribution center is owned by the city’s Industrial Development Board and leased to an Amazon affiliate. The center is on pace to be completed and operational by the 2011 holiday season.
While state officials usually are reticent to reveal the business prospects and incentives offered to companies, particularly in the early stages of the recruitment process, media reports have noted that Tennessee’s efforts with regard to the Amazon project have “carried the secretiveness beyond the wooing stage.” Specifically, according to these media reports,  Tennessee officials are refusing to acknowledge—citing taxpayer confidentiality laws—whether Amazon has been given an exemption from the state law that requires any retailer with a physical presence in the state to collect sales taxes on in-state purchases. At the end of the first week of April 2011, this was still the case in Tennessee. As in the South Carolina example, the Amazon deal was initiated under the former Tennessee governor in the waning days of the Bredesden administration. At that time, Governor Bredesden sought a rule change in state law that would exempt retailers from sales taxes if they sell at least 50 percent of their goods outside of Tennessee. Governor Haslam, Bredesden’s successor, has expressed support for granting the sales tax exemption to companies like Amazon but, in mid-February 2011, the state’s revenue commissioner cancelled a hearing on the rule change because of a freeze on new rules and regulations imposed by the new administration. Policymakers, such as  Tennessee Lieutenant Governor and Senate Speaker Ron Ramsey, in assessing the Amazon  deal, maintain the importance of determining the details of the incentives and note that it is “worrying because of Tennessee’s reliance on sales taxes.” In a similar vein, Senator Randy McNally, chair of the Senate Finance, Ways and Means Committee, noted that, “You could have the effect of eroding the Tennessee tax base. While economic development is a good thing, we want to make sure there’s a cost-benefit to the state.”
In terms of a lasting solution, regardless of the efforts initiated by states under the SSTA, the enactment of ‘click through’ laws requiring affiliate marketers to collect sales taxes, or sending tax bills to companies like Amazon, urgent action is required by Congress. The 1992 U.S.  Supreme Court ruling occludes states from initiating action to capture sales tax revenues at a time when state finances are under tremendous strain. The 1998 Internet Tax Freedom Act that places a moratorium on any new taxes on e-commerce transactions is another federal hurdle that has to be overcome by states. While there has been some Congressional action to overcome some of these obstacles, such as the Main Street Fairness Act sponsored by  Congressman Bill Delahunt, Massachusetts (and four co-sponsors) in July 2010, which aimed at placing online retailers on an equal footing with their ‘bricks-and-mortar’ counterparts  regarding the collection of sales taxes, the legislation did not make it out of the relevant  Congressional committee. In fact, only Congress has the authority to let states require the  collection of the billions of dollars in uncollected sales tax revenues from e-commerce  transactions. The measures initiated by states under the SSTA toward simplifying this sales tax collection process for online retailers and catalog companies, along with the massive revenue shortfalls that states have experienced (and will experience going forward), remain important factors that require urgent Congressional action. In fact, this Congressional action will help  mitigate one of the major structural flaws corroding contemporary state revenue systems and provide a more long-term solution to the vexing revenue challenges currently confronting every state.
For Further Reading:
E-Commerce.xls30 KB
AmazonFiscalAlertSLC.pdf2.38 MB