Inside Amazon's tax fight

May 23, 2013: 8:12 AM ET

What's really behind Amazon's tax war.

By Peter Elkind, editor at large

130522115010-fortune-cover-06-10-13-custom-1FORTUNE -- For many years, Amazon.com enjoyed a crucial leg up compared to traditional retailers like Barnes & Noble, Sears, and Wal-Mart: The e-tailer didn't charge sales taxes to its customers. The result: Amazon benefited from as much as a 10% pricing advantage over its rivals, one key reason behind the company's meteoric rise.

"It's no exaggeration to say you can't fully appreciate the rise of Amazon without understanding this fight," write Fortune's Peter Elkind and Doris Burke in the cover story for the magazine's new issue. Amazon's (not so secret) War on Taxes reveals how, for more than 15 years, Jeff Bezos's company successfully battled to preserve this edge—demanding, wheedling, suing, threatening, and negotiating—and how new alliances and strategies among Amazon's (AMZN) enemies have finally begun turning the tide. (Earlier this month, the U.S. Senate passed a bill that would close the Internet tax loophole for good.)

"There's a lot at stake," Fortune declares in this in-depth narrative. "For state and local governments: an estimated $11.4 billion a year in desperately needed cash for streets, schools, police, and parks. For Amazon and arch competitors like Wal-Mart: the struggle for retail primacy. For American consumers: what they pay and how they shop."

The article points out that "beneath its well-earned reputation for being customer-friendly—featuring a brilliant, affably cackling founder whom Fortune declared 'Businessperson of the Year' in 2012—the company is a brass-knuckled battler for every penny of competitive advantage." It shows that Amazon's tax strategy goes back to the company's founding.

Amazon says it's driven solely by principle. "Far from an e-commerce loophole," the company's top general in the tax fight testified in Congress last August, "the constitutional limitation on states' authority to collect sales tax is at the core of our nation's founding principles." But experts interviewed by Fortune variously say Amazon's approach is "very, very aggressive" and "just doesn't pass the smell test." Charles McLure, a former deputy assistant U.S. Treasury secretary and senior fellow emeritus at Stanford's Hoover Institution, accuses the company of "aiding and abetting tax evasion."

MORE: Amazon's (not so secret) War on Taxes

The story reveals how a decade-long federal effort by timid state tax collectors ended in failure, prompting Amazon's frustrated mega-rivals to take matters into their own hands, launching battles against Amazon in a dozen separate states—all in the name of small Main Street business.

When states tried to get Amazon to collect, the company responded ferociously. In South Carolina, the company announced it was cancelling plans to build a warehouse in the state, prompting legislators to flip-flop and approve a special agreement exempting Amazon from collecting sales tax until 2016. In multiple states, Amazon dumped thousands of small-time merchants who linked to its website and tried to get them to pressure state governments. In Texas, the company first denied it had a physical presence in the state—despite owning and operating a 630,800-square-foot distribution center with 119 workers—and then, when the state wouldn't capitulate, Amazon fired the workers and shuttered the warehouse. In each case, Amazon vowed to fight the state's "unconstitutional" action, before eventually negotiating a compromise that bought itself more time.

Indeed, far from suffering from the apparent turning of the tide (by January 2016, it will be collecting taxes from about half the U.S. population), Amazon has shown an amazing ability to turn each change to its advantage.

As late as 2008, CEO Jeff Bezos complained that local tax collection was so "horrendously complicated" that it imposed "an undue burden" on his company. But, notes the story, "not only was Amazon able to master the challenge by 2008—it had actually launched a service that was collecting sales tax for 2,500 merchants that used its website, including Macy's (M) and Target (TGT)."

Then there's this: Fortune reveals that three small municipalities in Texas, each the site of a new Amazon warehouse under construction, "have already agreed to 'rebate' varying amounts of local sales tax—as much as 85% in one case—to Amazon. This bonanza would run well into the millions." The article concludes: "After years of scorched-earth battles to avoid collecting sales tax, Amazon has managed to find a way to channel a chunk of that money—which comes out of its customers' pockets—into its own coffers."

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