The Ultimate Tax Dodgers: Internet Retailers

NEW YORK (TheStreet) -- There used to be a time when sales-tax evasion was a grimy business. It required a sleazy merchant and a greedy customer, conspiring to make the transaction in cash, "tax included" (wink-wink). Once there was a string of electronics stores on Manhattan's Lower East Side that survived by non-taxed transactions in "gray goods," in which the state tax authorities (and sometimes customers) were systematically cheated.

Today, of course, nothing has changed.

The merchants are still sleazy, the customers are still greedy -- only now, sales-tax evasion is both commonplace and organized. The name for this particular variety of organized crime is known as "Internet retailing." Thanks to a 1992 Supreme Court decision, Quill vs. North Carolina, mail-order and Internet merchants have no obligation to collect local sales taxes unless they have a physical presence in the customer's state. The result is that the entire country is now one big Lower East Side (but only rarely with acceptable pastrami).

With local governments facing layoffs and cutbacks, it appears that Congress is about to rectify this situation, in which Web retailers have a grotesque advantage over brick-and-mortar retailers. (And if you don't believe me, try finding a Tower Records outlet in New York nowadays.) Legislation requiring Web retailers to collect sales tax is getting support from both Democrats and Republicans.

One such bill is called the Main Street Fairness Act, which is detailed here. It seems increasingly likely that this bill, or something like it, is going to pass in Congress reasonably soon, and that is going to be an earthquake for both storefront and virtual retailers.

The unusually pro-revenue-collection sentiment in Congress became evident at a hearing of the House Judiciary Committeelast week, at which there was virtual unanimity, with even lip service by the Internet retailers in attendance, that hard-pressed state and municipal governments are entitled to collect the taxes that they are owed. Hell, an actual Texas Republican spoke in favor of forcing the net retailers to collect taxes.

But before we slide off into an era of good feeling and kumbaya, let's acknowledge that the campaign for and against taxing of Internet purchases has been beset by hypocrisy and doubletalk from virtually everyone involved.

First of all, it's reasonably plain that no matter what they may tell Congress, Internet retailers are dead set against collecting taxes on purchases. The unfair advantage this gives them over brick-and-mortar retailers has sustained them over the years.

Second, while brick-and-mortar stores talk about wanting a "level playing field," the biggest of them, Wal-Mart ( WMT) -- conspicuous by its absence on Thursday -- would go out of business fast if it didn't use its corporate power to muscle suppliers and employees. And if I had a penny for every large shopping center that used government largesse, tax breaks or low-cost urban renewal land to set up shop, I could probably afford to open a shopping center of my own.

Unsurprisingly, a lot of money is being poured into lobbying both Congress and the public -- witness the full-page ad from shopping centers in the New York Times on Monday -- and the stakes are proportionally high. The weakest among net retailers -- notably Overstock.com ( OSTK), whose CEO, Patrick Byrne, was the only Web CEO to speak on Thursday -- face serious trouble if they lose that tax-free advantage. Overstock faces default on its bank-lending covenants, as blogger Sam Antar discovered from perusing its latest quarterly report.

So this is going to be a volcanic event for all Internet retailers, whether they're giants like Amazon.com ( AMZN), Dell ( DELL) and eBay ( EBAY) or smaller players like Blue Nile, whether or not they already collect state sales taxes. Even among the Web retailers, there is a wide variation in tax-collection practices, with eBay in particular being host to many small merchants that aren't too particular about tax collection.

Amazon.com has positioned itself in the tax debate with typical adroitness and seems poised to crush its principal competitor, eBay. Plans to require Internet-sales-tax collection all contain exemptions for small retailers, and Amazon would like to set them as low as possible, so as to not allow eBay's merchants from not collecting taxes.

In an effort to get ahead of this political tsunami, Amazon dominated the next day's headlines by telling the Judiciary Committee that it "strongly supports" sales tax collection. If, that is, the small-merchant exemption, currently envisioned at $500,000, was made lower. EBay, naturally, wants the limit to stay as high as possible.

Amazon's acquiescence, meanwhile, made mush of Byrne's dubious claim that modern software wasn't up to the task of doing something as complex as computing the correct sales tax for each customer.

If the Internet retailers get socked with a sales tax, they have pretty much themselves to blame. They've been outmaneuvered by the brick-and-mortar stores, who have successfully presented this as a David vs. Goliath battle. But in a sense there's also the historical fact that no business model predicated on cheating the government ever works. Amazon, by supporting the legislation, is simply going along with the march of history.

Just as there is no Tower Records anymore, there are very few gray-goods stores to be found on the Lower East Side. Most have been supplanted by the Internet. And even on the net, price-comparison services like the Priceblink Web browser plug-in are gnawing away at Web retailers' competitive advantage.

I know, paying taxes is annoying. But even the Internet retailers, their laissez-faire anti-tax arguments notwithstanding, rely upon government services like the Postal Service to get goods to their customers. And if they use private services like FedEx ( FDX), those package-delivery trucks travel on roads maintained by local taxes. For years, the net has taken advantage of those goodies without collecting a dime, and profiting from the resulting "discount." It's high time that free ride came to an end.

Gary Weiss's forthcoming book, AYN RAND NATION: The Hidden Struggle for America's Soul, will be published by St. Martin's Press on Feb. 28.

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Gary Weiss has covered Wall Street wrongdoing for almost a quarter century. His coverage of stock fraud at BusinessWeek won many awards, and included a cover story, �The Mob on Wall Street,� which exposed mob infiltration of brokerages. He uncovered the Salomon Brothers bond-trading scandal, and wrote extensively on the dangers posed by hedge funds, Internet fraud and out-of-control leverage. He was a contributing editor at Conde Nast Porfolio, writing about the people most intimately involved in the financial crisis, from Timothy Geithner to Bernard Madoff. His book "Born to Steal" (Warner Books: 2003), described the Mafia's takeover of brokerage houses in the 1990s. "Wall Street Versus America" (Portfolio: 2006) was an account of investor rip-offs. He blogs at garyweiss.blogspot.com.

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