14 December 2010

The upcoming tax hike no one is talking about

There's heated debate going on right now about the compromise bill on what taxes are fair and what groups should (or should not) be subject to tax hikes if the Bush cuts are rolled back. There's another tax creeping up on us that will hit each of our pocketbooks more directly since it's tied to consumption.... the internet commerce tax. As much I hate giving more money to the government, I think its fair, especially if you take into consideration the hidden economic costs of the status quo. And get ready for it folks, its coming soon to a computer near you.

Consider this situation - Atmabus is looking to buy a Dyson vacuum for $399. It's the same price at both Best Buy and Amazon. At a 9% sales tax rate, my purchase is roughly $36 higher if i patron my local Best Buy - a no brainer for me. The way the tax rules work - internet commerce is not taxed, historically because its been difficult to establish jurisdiction. These sales have been viewed as interstate commerce; sales tax is governed by state and local authorities. Advantage: Amazon. Just today, Best Buy announced terrible earnings citing market share losses. Certainly their offline and online competitors are running faster than them; but the tax arbitrage situation has added fuel to the fire.

All things being equal, we're dissuading people from shopping at their local stores - a big economic cost to cities. It's one less sale to justify a new employee for Best Buy, and one less sale that circulates money locally (real estate, restaraunts, etc...). Also - the likes of Best Buy create more jobs than Amazon since their retail model is more labor intensive than ecommerce companies. So what is the cost ?

Amazon had sales of $25B last fiscal year (and growing), much of which had no sales tax applied to it. Assuming 90% of their sales were untaxed a 9% average sales tax rate, that would have generated $2B for state economies. Not enough to plug the CA budget hole, but not pocket change either. And this is just one ecommerce company, imagine applying this logic to all online sales.

Best Buy generated $50B last year. They employeed 180,000 full time employees. Amazon, which had half of Best Buy's revenue, employed a meager 25,000. For every dollar of revenue created by Amazon, it translated into 1/4 of the jobs than it did at Best Buy. Applying this ratio to Amazon's sales, this means 65,000 less jobs created. 65,000 less people with disposable income, paying payroll taxes, and circulating money locally. I know this is a bit of a generalization, but you get the point. Again, this is one example, imagine if you apply it more broadly.

I'm not saying that we should end ecommerce and source everything locally, but it doesn't make sense to give Amazon a competitive advantage when they clearly do not need one. Why should i have to pay $36 to my local Best Buy who employs people versus Amazon which does not ? Given the pressure on local government agencies to find new sources of revenue, they will no doubt jump at ecommerce. Many states have already done so and many are planning on it.

So as i blogged about earlier, i told everyone to take advantage of the short-lived free services the net currently affords due to its nascency. I'd now also load up on all your christmas gifts for the next several years to save another 9% that will hit in the years to come.


  1. While there is an argument for an internet tax around limiting tax-arbitrage-based competitive advantage, there is also a fairly compelling argument against it: That it keeps a lid on local sales taxes by keeping local consumers from being "held hostage" by their local government. So while a local company might be more convenient, an internet firm can have a price advantage and keep a local government from taking advantage of its position to extract value from taxpayers. In addition, a Best Buy store uses local resources such as police and fire protections, and its employees also use local resources. In contrast, Amazon will depend much less on local resources (just roads, really).

    Also, talking about saving local jobs at less efficient firms is economically irresponsible. You could make similar arguments for eliminating snail mail and outlawing robots to save jobs, not to mention reversing globalization in general.

  2. Fair points you make. While Best Buy uses some public resources, its not very much. They pay for most of the ones they use (ie. electricity, water, etc..). The employees are being taxed on property, income, etc... In the old days when distribution was more localized, retailers might have used more local resources, but the supply chain difference between BBY and AMXN is probably negilible. Most of it resides outsides of the local county anyway. We as consumers utilize most of the public resources (schools, etc..), not business.

    I am not for thwarting efficiency, but there is no reason to give Amazon a 9% advantage. If there is a tax, it should be uniformly applied. Let BBY and AMZN duke it out based on the merits of their offerings and not on a tax loophole.

    I think the "held hostage" argument questions the fairness of a sales tax in general, which is actually very interesting point that I didnt think about. And to close, A tax on robots? Why not :).

  3. The internet tax holiday was something in place in the late 90s to ensure the development of the e-commerce industry. Nonetheless, this was extended several times (first 2-4 years from around '96 to about '00) and then kept in place and I am not sure it was really revisited with the dot-bomb slow down and now re-emergence.

    Now that the industry has fully developed and matured, agreeably there should be a level playing field. From the perspective of running e-commerce businesses that have been global in many other countries ranging from the Philippines, Turkey, India, Europe, etc. a VAT or some form of GST has to be applied either directly into the price or deducted or charged on top of the service delivered. The viewpoint here for most countries and the internet is that tax has to be paid local to the jurisdiction where that person is. And always the local country argument is that they are losing revenue because those consumption dollars or liras or rupees would have gone elsewhere into the local or international economy. There is no need for the "internet" to flourish independent of taxing. I agree, becasue the internet is just another massive and more efficient distibution channel. Why would it be different if I was doing modern sales via 1880s telegraph technology using Morse Code or why do telephone sales incur a state sales tax? However, for US or many purchases made directly into US based servers there is no tax and hence an overall advantage previals if the sale is conducted 'in the US.'

    With states in record fiscal deficits (largely due to unemployment funds which need to fund those payments back to the Federal goverment) and record loss of tax revenues, I agree something needs to be in place to level the playing field.

    The contrarian argument could be technology strives for efficiency. Efficiency drives productivity and productivity equals more profit and less costs. Syllogistically, less jobs.

    But what happens when these shifts occur globally? For example, not only because of mechanization and mass production, we should take a look at the textile industry. In the 1800s (early) India was one of the leading producers of garments for which the British shifted to the various mills of 1850s Industrial Britain rendering the country into a mercantilistic relationship of providing raw materials.

    What eventually happepened is America came along (at that time there was not taxation) and cheap labor and investments (mind you, mainly from Britain) first came to New England. Textiles shifted there and then within 50-60 years these same states were complaining of jobs being shifted to the American South ("I'm fixin to do'in"). And now we it recycle back to China, India and other countries. Is this a level playing field? Do we know if garments or other matters are taxed accordingly either in input prices or the final sale, specifically if they were online?

    I suppose that is an argument for input prices versus final sale prices. The analogy I am trying to illustrate is there probably will not be level playing fields either intra-country or inter-country, but where it can be applied or enforced easily (like the United States), for its own benefit it should be done so. Your Best Buy and Amazon illustration best exhibits this. From a purely economical point of view, it probably makes best sense for Best Buy to adapt to change and then become its own Amazon? That means 180,000 less jobs, but eventually as with the textiles and telephone switchboard operators those jobs would shift into something else. I mean how many telegraph operators are there in the US today? Is modernization at fault here?

    Lastly, should US do away with State taxes and have one uniform sales tax code like most of the world? I suppose that is an argument for Federalism vs. State's Rights and bringing up 10th grade social studies. It would make things easier for US online retailers rather than employing 50 sets of tax rules and remittances if there is an internet tax.

  4. Lots of good stuff here. First, I assumed internet commerce was not initially taxed because they wanted to get the industry off the ground, but did not know it was such an overt conscious decision.

    I suppose you're right that with the complexities and interdependencies of global economics, that it's virtually impossible to make things "equal." However, AMZN and the other companies are so much more successful than the incumbent retailers, that it's just irresponsible to continue to give them in effect a tax subsidy.

    There was probably some misinterpretation, I do not think we should thwart efficiency and progress. In fact the opposite is true. Sumeet's right on - best buy needs to change and adapt if it wants to survive. Yes that may impact the 180k employees, but it will be worse if they dont fix their model to ensure long term sustainability (ie. blockbuster).

    I also like you're idea of a VAT / uniform tax to make it easier for businesses to comply, but we all know trying to change 50 states will be impossible.