States fire shots in Internet sales tax war

(breakingviews.com) -- A battle is brewing over U.S. state sales taxes on online purchases. Internet retailers Amazon.com and Overstock.com are scaling back their operations in states that demand they collect these taxes. While this won't dent their revenues much, it foreshadows a larger clash over the taxation of internet commerce. Cash-strapped states are firing the first shots.

Most online sales escape being taxed because internet firms only collect them in states where they have a physical presence. (Buyers are legally bound to pay them, but many do not.) However, Amazon (AMZN, Fortune 500) and Overstock (OSTK) allow independent companies to sell merchandise through their systems for a fee. This means the online giants have to collect taxes in any state where their independent partners have operations.

New York passed a law last year implementing this rule. Amazon and Overstock both challenged it in court and lost. Now Hawaii, North Carolina and Rhode Island have passed similar measures. In response, both companies have cancelled their so-called associate programs in those states.

That's not too painful; only about 10% of Amazon's sales come from associate sales, according to Forrester Research. And these indirect sales generate lower margins than the company's main business.

But it could become a bigger problem over time. The amount of business done online has grown rapidly -- it is expected to hit nearly $160 billion this year, says Forrester. That has led bricks and mortar retailers -- which feel at a disadvantage because they must collect sales taxes -- to call for online retailers to be required to do so also. States desperate for more revenues are beginning to agree.

Indeed, there's no reason why online retailers shouldn't be forced to collect sales taxes like other businesses. They once argued that doing so would inhibit the growth of online businesses. But that's clearly an out-of-date position. Tax codes should be updated to reflect the growing importance of internet commerce.