Will California's 'Amazon tax' cause an affiliate exodus?

June 29, 2011: 9:30 PM ET

Will California's law forcing out-of-state retailers to pay sales taxes help it raise hundreds of millions in revenue? Or will it just force Amazon's affiliates out of state?

FORTUNE - California Gov. Jerry Brown on Wednesday signed the so-called "Amazon tax" into law. The measure forces out-of-state retailers (not just Amazon) to pay taxes on sales within the state. Earlier on Wednesday, Amazon (AMZN) sent notices to its affiliates in California, warning them that if the measure became law, the company would have to terminate its contracts with them because it's the affiliates' presence in the state that makes Amazon subject to the tax. Amazon has pulled similar maneuvers in other states where such taxes were imposed.

California, like other cash-strapped state governments, is flailing about for new sources of revenue. Proponents of the tax claim it will raise $317 million in revenue a year. But California should look around at other states that have tried this tactic: it usually doesn't work out so well.

A 1992 decision by the U.S. Supreme Court in Quill v. North Dakota held that online sales are not subject to taxation unless the seller has a physical presence in the jurisdiction imposing the tax. That has allowed Amazon and other retailers to undercut competition from bricks-and-mortar retailers by selling tax-free in states where it has no physical presence.

In its notice to California affiliates (technically including me, though I've never sold a thing through Amazon), the company calls the measure "unconstitutional and counterproductive." Amazon (AMZN) notes that it was "supported by big-box retailers, most of which are based outside California, that seek to harm the affiliate advertising programs of their competitors."

That might be a slight mischaracterization. It's hard to imagine executives at Wal-Mart (WMT) sitting around a conference table, plotting ways to "harm" Amazon affiliates. And those companies have a point: Amazon and lots of other online retailers get to sell competing goods without having to pay the taxes the brick-and-mortar outfits must pay. That's not fair.

But fairness isn't the only consideration here. For one thing, there's that pesky Supreme Court decision. The California tax is like similar measures passed in other states in that it amounts to an end-run around that decision. Amazon might not have a physical presence in California, but its affiliates do. It's really not that simple, though, because whether through an affiliate or not, the actual transactions are between Amazon and the customer. Affiliates in the company's Associates Program simply send traffic to Amazon, and take a cut when a sale is made. In New York, only about 1.5% of Amazon's sales in that state came via affiliates before that state's "Amazon tax" was passed.

Despite the moniker, the "Amazon tax" applies to all online retailers that don't have a physical presence within California. Rebecca Madigan of the Performance Marketing Association, which opposes such taxes, says most affiliates who will be affected in fact don't work with Amazon, but with hundreds of other retailers. Some of the bigger ones include Overstock.com (OSTK) and Drugstore.com.

New York State passed its tax based on the notion that affiliates are basically storefronts for Amazon and other retailers. That measure is making its way through the courts, and Amazon is depositing the collected taxes in an escrow account until the case is settled.

In other states, such taxes have backfired, according to John Henchman of the Tax Foundation, a nonpartisan group that opposes the such taxes. Henchman has noted that tax receipts have actually fallen in Rhode Island and North Carolina as a result of the imposition of "Amazon taxes." A big affiliate, FatWallet.com, fled to Wisconsin from Illinois after the latter state imposed such a tax, he notes.

California could lose 25,000 "small businesses," according to CalWatchdog, which calls itself an "independent journalism venture," but which is backed by the libertarian Pacific Research Institute. That number comes from the Performance Marketing Association. Madigan, its executive director, told me that it includes anyone who has sold at least $25 worth of goods. So the true number of people who will lose their livelihoods is hard to pin down. But losses there will surely be.

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