Tax Revolution in the States and the Death of Affiliate Marketing

The business model generally known as Affiliate Marketing, but more correctly described as Performance Marketing, is an industry that has grown by leaps and bounds over the past decade, and is now the focus of state governments across the county, in misguided attempts to add revenue to state coffers.

What is Affiliate (or “Performance”) Marketing? Affiliate marketing is basically a form of advertising. Online merchant sites, from the very biggest including Wal-mart, Target, Macy’s, Best Buy, Home Depot, etc., to the smallest mom-and-pop sites selling hand made products out of a garage, have found that they can greatly increase their sales by allowing other website to display their products, with links back to their own site. When a visitor of one of these “other” sites – an “affiliate” site or a blog – sees a product he or she likes, and is “pre-sold” on making a purchase and clicks the link, he or she is then transferred to the merchant site, where the merchant does the rest: The merchant sells the product, collects the money, and delivers the product. For advertising the merchant’s product in this fashion, the performer, the advertiser, the affiliate, whatever you would like to call them, has then earned a commission, which could be 1%, 5%, 10%, or more, of the product’s sales price.

In order to advertise such products and earn commissions, affiliates spend countless hours designing and building websites, creating on an ongoing basis original content in order to rank in search engines, search merchants and affiliate networks for products, add product information and descriptions to sites, and continually update sites in order to have in-stock and desirable products to offer. Affiliates also spend significant amounts of money on online advertising, just as merchants do.

This is a labor-intensive, 24/7 business. Success does not come easily. The vast majority of the hundreds of thousands of people who enter the world of affiliate marketing struggle and eventually fail – but thousands do succeed. It has been estimated that there are over 25,000 affiliate marketers in California alone, and more than 200,000 in the United States. theHoundDawg is one one them, working in this field now for almost ten years.

The existence of the Affiliate Marketing industry is now threatened by ignorant state legislators across the country.

Most, if not all US states have been suffering some degree of financial crisis since the onset of the 2008 recession. Virtually every state imposes a sales tax on in-state purchases of tangible property (and recently some states have expanded or tried to expand this to services and non-tangible property) and what is called a use tax, on purchases of tangible property made out-of-state. Collection of use taxes has always been a problem for states, as out-of-state merchants generally have no connection, or “nexus” with another state that would, on a Constitutional basis, require such out-of-state sellers to collect a tax and pay it to another state.

In the past couple of years, an ever-increasing number of state legislatures have attempted to create a legal fiction of a nexus between out-of-state merchants and their state, by saying, with no basis in truth, that affiliates are “agents” of out-of-state merchants. In effect, they are saying that Mr. X, who sits in his dining room and places links on his blog advertising products sold by a merchant located in another state, a merchant who has no other connection whatsoever with Mr. X’s state besides shipping orders to that state, is not merely disseminating advertisements, but is a “sales agent” for the merchant, who now has a legal duty to Mr. X’s state to collect sales tax on ALL orders to that state, and to pay those taxes over to that state.

State legislators are under the mistaken belief that merchants will undertake this obligation willingly. Boy, are they wrong, as they fail to understand the burden they are imposing. Merchants have to be able to compute the tax at the proper rate, which can vary in some states from city to city, or county to county. They then have to collect the tax, prepare returns, and turn over the tax, on what ever basis the state requires – for EVERY SEPARATE STATE THAT IMPOSES SUCH A BURDEN.

Legislators who are proposing and passing these bills requiring the collection of use taxes by out-of-state merchants (generally called Affiliate Taxes or “Amazon” Taxes) have reasons beyond their belief in a potential windfall of a new income stream. They are being lobbied by two separate interests, associations of brick-and-mortar businesses, primarily booksellers upset by the market share taken over in recent years by Amazon (hence the references to “Amazon” tax), and major national retailers, primarily Wal-mart, who have an existing presence in every state and already collect and pay taxes for every online sale. The B & M merchants’ interest is to level the playing field with online merchants that do not currently add tax onto the cost of sales, as they do. Wal-mart and other national retailers have a very different interest, which I will return to in a bit.

The first state to pass an “Amazon” tax was New York, followed by North Carolina, Rhode Island, Colorado, and Illinois. Such laws have been proposed and are pending in other states, including California. The constitutionality of the concept is under review in the New York courts, but it is years away from resolution. Lawsuits were filed by Amazon and another major online-only merchant, Overstock.com. The cases were originally dismissed by a New York state court trial judge, and on appeal, more than a year later, reinstated for further proceedings at the trial court level to determine whether or not the law is constitutional as applied to the factual situation inherent in the Affiliate Marketing industry. A final resolution in the courts is perhaps five years away.

In my state, California, an attempt was made to pass an “Amazon” tax a couple of years ago, and the legislature actually did pass it, but it was vetoed by Action-Hero governor Arnold Schwarzenegger. A new bill, AB153, has been introduced this term, and was this past week passed by the Assembly Revenue and Taxation Committee, with a vote of 5 ayes, 2 noes, and 2 abstentions. It is now awaiting hearing before the Appropriations Committee.

So, why is it that an “Amazon” tax could mean the Death of Affiliate Marketing?

The answer is simple, and astoundingly, totally ignored by these astute state legislators, plowing ahead with bills imposing the tax collection burden: Merchants, big and small, that do not already have a presence in a state requiring them to collect sales/use taxes all along, will NOT do so now. Their response has been NOT to start collecting the tax, but to terminate their affiliates in each state passing such a law, destroying the affiliate marketing businesses of their former affiliates.

In state after state, this has been the response of hundreds of merchants, from small merchants who realistically cannot undertake the compilation and paperwork burden of an “Amazon” tax, to Amazon itself, and other online giants, such as Overstock, CafePress, CSN Stores, Deep Discount, Home Shopping Network, LampsPlus, etc., etc., etc.

By terminating their affiliates from their programs, the merchants are wiping out thousands of small businesses across the states who have passed “Amazon” tax laws. It happened in New York, it happened in North Carolina, it happened in Rhode Island, it is happening now in Illinois where the law was passed just last month, and it will happen in California should the bill become law. Losing these affiliate relationships does not automatically end an affiliate business, but for the vast majority of affiliate marketers, it reduces income by 25%, 50%, 75%, and for some, 100%. Thousands in these states have left affiliate marketing, and untold numbers of others have left the state for hopefully greener pastures. In California, Amazon and Overstock have told us that if the law passes, we are terminated.

What has the overall result of “Amazon” taxes been in the states passing them? Overall REDUCED tax income, as they have gained virtually NOTHING in increased tax revenue from the new tax collection efforts, and LOWERED income and sales tax revenue from the fact that thousands of small business owners now have drastically reduced incomes (or no income at all) and are paying reduced income taxes and with decreased buying power, personally contribute far less to sales tax revenue.

Here is a great article from NewsBlaze.com on the issue: Can Online Tax Measure Destroy 25,000 California Businesses?

This article quotes an opponent of AB153, State Senator George Runner, as follows: “I am disappointed by the Committee’s decision to move forward with a tax measure that will cost California jobs and hurt state revenues. There are as many as 25,000 internet affiliate businesses based in our state that could be wiped out by this bill.”

So why is Wal-Mart lobbying FOR these laws? Because they are already in every state and collect state taxes on all online sales, and because they operate their own massive affiliate program – one that is very affiliate un-friendly, with harsh terms of service and extremely low commission rates. Their position is that if other, better, affiliate programs terminate their affiliates, those affiliates will come running to the Wal-Mart affiliate program, in an effort to retain a portion of their business.

There is a solution to this problem, one that can actually provide increased revenue to every state, provide a level playing field for online affiliates, merchants, and Brick & Mortar stores: A uniform, national internet sales tax, where every state receives a fair revenue stream and where all online merchants regardless of whether or not they have affiliates, and regardless of their location or their affiliates’ location collect sales tax based on a uniform rate.

However, for there to be a uniform national internet sales tax, three or four separate things have to happen:

1. Every state has to agree to vacate its own sales tax system as far as internet sales is concerned. The Federal government may or may not be able to add a national tax, but it has no power to vacate the sales tax laws of individual states. Without the agreement of each state, a national tax would be an additional tax, not a substitute tax;

2) There must be a significant change in the political make-up of Congress. Republicans will never support this tax; there would have to be a significant Democratic majority (no Blue Dogs) in both the House and Senate to ever pass a national internet sales tax;

3) Both houses and the President would have to understand the need for a uniform tax and then get it done;

4) The trickiest issue is the Constitutionality of such a tax and the big question is as to whether or not the Federal government has authority to pass such a tax. As with income tax, it may well require a Constitutional Amendment, and that would take many years and the likelihood of passage would be highly questionable.

An additional problem, however, is how to determine a fair uniform tax rate. Most stales have sales tax rates of around 5% and the public and politicians in those states would be up in arms to see a national internet sales tax rate of maybe double that. California politicians, on the other hand, would be loath to agree to a rate of 5, 6, 7% or so, when the rates in CA vary from about 8.75% to the 9.75% in LA County. And of course, there are some states that do not now impose a sales tax. Plus the national rate would have to be high enough for the federal government to get its share – if only to pay for the costs of administering the program – over and above what the states will receive.

But, there is no other fair, equitable option.

State legislators cannot continue to ignore the realities of an “Amazon” tax, forcing affiliate marketers out of business, for their own selfish, misguided interests.

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April 6, 2011 Addendum: “Follow up to the States’ Efforts to Destroy the American Industry of Affiliate Marketing”