Take Five: The taxman cometh for online retailers?

It sounds like an election-year suicide pact: Congress is currently considering legislation requiring Internet-only retailers to collect taxes on online purchases – something they have not been forced to do since a 1992 Supreme Court decision exempted businesses from collecting sales taxes in states where they do not have a physical presence.

But analysts like Steve Noll, a marketing professor with Madison College, are quick to point out that the legislation would not actually levy new taxes. It would merely shift the burden of responsibility from consumers, who are already required to pay sales taxes on online purchases, to online retailers.

The problem? Mainly out of ignorance and negligence, few consumers actually declare their online purchases on their tax forms, and this has cash-strapped states appealing to Washington for help. It’s also pitted many online retailers, who understandably don’t want to be forced to collect taxes from customers in thousands of different tax jurisdictions, against traditional brick-and-mortar retailers, who have complained bitterly for years about the quasi-tax free status their Internet-only counterparts’ products enjoy.

We talked to Noll, who teaches an e-commerce course for Madison College and has a more than 20-year background in retail, about issues surrounding the House of Representatives’ Marketplace Equity Act and its Senate counterpart, the Marketplace Fairness Act. A hearing was held this week on the Marketplace Equity Act, and a hearing is pending on the Senate version.

Why do you think this legislation is gaining traction now? Do you think it’s simply a result of state budget problems, or are there other factors to consider?
What’s happening now is a combination of factors. Number one, obviously, the budget crisis has been an issue. Everybody is trying to find where the money is, and I know just in Wisconsin alone the state probably missed out on about $150 million in the last year. So that’s a significant chunk of change that’s being left on the table.

So I think the budget crisis has made people scrutinize everything a lot more. But the other thing is that there’s been a revolution in retailing over the last 10 years, moving more toward online retail. And we’re hearing about big companies like Best Buy that are having some really serious financial issues, and a lot of it is because of what is called showrooming.

"This is a real mess, but given how much money is out there and given the economic state of the states, unfortunately someone has to kind of take the reins and muddle through this." – Steve Noll, Madison College

Showrooming is where you go into a store, like a Best Buy, you look at a computer, you pick it up, you touch it, and then ultimately you just take your phone out and check the price on Amazon or someplace else, and in addition to possibly being cheaper, you don’t have to pay sales tax on it. So consumers will go to Best Buy to look at the product but buy it from somewhere else. So they’re starting to push some of this legislation as well. Walmart is another company that’s doing that. And when you have players like Walmart, the biggest retailer, starting to really push for this type of legislation, that’s what’s started to get the attention of legislators.

So I think it’s a combination of things. It’s the economy, but it also is just a natural evolution of retailing. Business changes and evolves, and it’s evolving now and evolving in a way that’s negative for a lot of businesses. So they are starting to fight back and saying, “Hey, this is not fair.”

How aggressively are retailers like Walmart lobbying for this, and is that a fairly recent development?
Yes, I think they’re getting more and more aggressive. Part of this, interestingly enough, is being led by Amazon. The way that Amazon works is if they have a physical location in a state, they need to collect sales tax. So, for example, if they had a warehouse here in Wisconsin that they shipped product out of, then Wisconsin customers would be subject to sales tax.

Amazon is really pushing through a same-day delivery model because online retailers know that that’s kind of the magic thing that people want, this instant gratification feeling, and that’s been the one thing that online struggles against is that you buy something and then you’ve got to wait a few days. So by adding more distribution centers, they will be able to move toward a lot more [same-day delivery]. That’s kind of a Catch-22 for them, because the more locations they have, the more places that they’re going to have start charging sales tax. And we just saw a deal that New Jersey did. They cut a deal with Amazon to build major distribution centers out there in exchange for them not enacting a tax on them for two years.

Is the writing on the wall for the closing of this loophole? Even if the current legislation doesn’t pass, do you think it’s just a matter of time before something does?
The thing is, right now, there’s technically no need for legislation because it is in the hands of the consumers to report this. There are two ways to go about doing this. You could go after the consumers themselves, and a lot of smaller businesses – especially online small businesses that would be hurt by this – their response is that there are laws in place right now. The fact is, consumers are not following the law. They’re the ones breaking the law, so [small businesses say] we should be going after them. I just don’t think that’s realistic and practical.

 

The other thing is, you can change the laws and put it into the hands of the businesses to be responsible for collecting that. There are two issues with that. Number one, it’s going to hurt smaller online retailers because now they’re going to have to create the infrastructure to collect that stuff, to process that. And, of course, every city, every state, every county has slightly different sales taxes. It’s not like it’s 5-1/2% everywhere. And then there are questions like, say I’m traveling in California and I buy something and have it shipped home to Madison. Is it subject to the California sales tax or is it subject to where I’m shipping it to? That’s just an accounting nightmare, a logistical nightmare to figure out.

And then there is the whole issue of this coming across to the general public as a new tax. And, of course, in this political climate, that’s just suicide to talk about creating new taxes, especially on consumer goods. The irony is, it is not a new tax, but it will totally be spun that way by whoever is against it. And that will make sense because people now think an advantage of online shopping is that there’s no tax. They just don’t get that, yes, there is a tax, but it’s your fault that you’re not paying it. So it’s a lose-lose.

This is a real mess, but given how much money is out there and given the economic state of the states, unfortunately someone has to kind of take the reins and muddle through this.

You alluded to the burden on smaller online retailers. How significant is that?
It could be significant. Imagine this. Say that I start an online business running out of Sun Prairie, and I build it up to 20 employees, and we’re shipping cheese, for example, all across the United States and running a successful, profitable business. If I were to have to start collecting sales tax from everywhere, I would probably have to hire two, maybe three people to handle this – certainly another accountant, somebody in IT – because it all depends on what infrastructure I’ve built my online business around. It’s possible that my whole online software, like my shopping cart and all that, may not be set up either to collect tax at all or to deal with the variable tax rates. Think about that. You need to know the tax rates of any city or county in the country, anywhere you’re shipping to.

So if I’m running a profitable business with 20 employees and now I have to go up to 22 or 23, that may move my business from profitable to struggling or maybe even unprofitable. If I had 500 employees, I still probably only need three people. That’s not going to be such a change. So it really depends on the size of the company. One thing I don’t know is how many online businesses with 20 employees are out there. But I do know that seems to be a fairly accurate number for a start-up company like that.

That said, there are issues of fairness with regard to smaller brick-and-mortar stores. What about their argument that they’re at a considerable disadvantage?
Oh, yes, absolutely. They’ve been at a disadvantage for a long time, because that’s really the level of retailer that’s being hurt. There is one theory out there that as retailing continues to evolve that we will end up with two levels of retailing. You’ll only have online mass merchants. So for CDs, DVDs, and basic clothes and all that stuff, you’ll go to an online retailer. And then all that will be left will be independent [brick-and-mortar] mom-and-pop specialty stores, and there will be nothing in between.

It’s interesting to think about a future like that, where if you need some T-shirts or some socks, instead of going to Kohl’s or something, you have to order them from Amazon because Kohl’s has gone out of business, or at least the physical locations of Kohl’s – they may still exist as an online retailer.

Do you have any predictions about where this legislation is going? It sounds like some Republicans are getting onboard. Is that a key to getting this passed?
I think so. Having the Republicans aboard, especially when you’re looking at some bigger businesses like the Walmarts of the world and all that, I think they realize that something has to be done, and ironically it takes the decisions out of the hands of the people, which kind of goes contrary to their philosophy.

I personally think that something needs to be done. Consumers need to see taxes on this stuff. It’s what keeps things going, and the fact that people have gotten a free ride for so long, they should be happy about that. On the one hand, I think they need to do it, but this is going to be such a political firestorm that it wouldn’t surprise me if this gets shelved at least until after the November election.

Do you have any other thoughts on this?
With respect to independent retailers, especially the mom and pops, the stand-alone non-Internet-based ones, those are the businesses that I have really felt for because they’ve been getting the bad end of the stick for years, and you have to kind of look at [this legislation] and say, well yeah, this could potentially hurt businesses that have started up that are Internet-only, but it’s already hurting independent businesses that maybe have been around for generations.

So I think something needs to be done to level the playing field. It’s unfair that businesses can use taxing as a competitive advantage. I think a business should stand on its service and products and not on exploiting a tax loophole.

Sign up for the free In Business Wisconsin Report – your weekly resource for local business news, analysis, voices, and the names you need to know. Click hereIf you are not already a subscriber to In Business magazine, be sure to sign up for our monthly print edition here.