Amazon.com and the Marketplace Fairness Act

Introduction

Amazon is an American online retailer, whose headquarters are based in Seattle, Washington. The firm was founded in 1994 by its current CEO, Jeff Bezos. The company began as an online book retailer but soon expanded to a much broader retail offering and has become synonymous with online retail worldwide. It has online sites for 12 countries and ships to several more. In 2013, its total revenue was $74.4 billion with a net profit of $274 million.

The Marketplace Fairness Act of 2013 is a proposed piece of legislation which will enable all state governments in the United States to collect sales taxes from remote retailers (that is, retailers with no physical presence in their state). The Act has been proposed bilaterally in the US Senate in an effort to promote a more equitable tax system. The Act is particularly relevant for an online giant like Amazon, which is one of the remote retailers which falls under the Act’s remit.

Analysis

I don’t think there’s any doubt that there’s any doubt that when you have one set of rules for bricks-and-mortar retailers and no set of rules for online retailers, the bricks-and-mortar retailers are at a disadvantage. (from Johnson, 2012)

Jason Brewer, Retail Industry Leaders Association

As outlined in the introduction, the Marketplace Fairness Act was proposed to provide a more equitable tax system in the United States. The Act sets to modify a situation whereby companies without a physical presence in a state are not required to pay sales taxes in that state on purchases made through their company. The Marketplace Fairness Act will apply to all remote firms, (online, telephone or mail-order) with an annual revenue of over $1 million.

The issue of remote sales has become an increasingly relevant issue as Americans consume more online (see left). With e-commerce fast approaching half a trillion dollars in the United States, the Marketplace Fairness Act provides a good opportunity for states to gain access to previously untapped revenue.

The Marketplace Fairness Act is likely to be just the first step in online tax compliance; merchants using sites such as eBay for their remote sales will also be included under the terms of the Marketplace Fairness Act. In 2012, the tax gap was estimated by the IRS at $385 billion (Rawlings, 2013) so the amount under-reported from these separate online transactions could also be considerable.

Calculating how much the act will generate in taxes is no easy task. There are around 11,000 tax jurisdictions in the United States (Rawlings, 2013) Also, it is not unreasonable to assume that some of the sales made through e-commerce would otherwise be made through local, tax-exempt purchases.

The Marketplace Fairness Act is of particular relevance to Amazon as it only has a presence in 17 different states. (source: Amazon.com) When one considers that 5 states have no sales tax and that Amazon has presence in 2 of these (New Hampshire and Delaware), it means that before the introduction of an online sales tax, Amazon would be paying a sales tax in 15 out of a potential 45 states. Clearly, the application of a sales tax in 30 extra states would be a burden to Amazon.

How has the law impacted (or how will it impact) on Amazon

A study by Baugh et al (2014) shows that  an online sales tax (sometimes referred to as an “Amazon tax” as it will be affected most by its implementation) will materially affect sales at Amazon. The authors examine five states (California, Pennsylvania, Virginia, New Jersey and Texas) which implemented a sales tax on remote retailers, effectively preempting the Marketplace Fairness Act, between 2012 and 2013. In these 5 states alone, consumers reduced spending by 9.5%.

In fact, the law seems to tie in with Amazon’s strategy of same-day delivery anywhere in the United States. In order to reach this goal, it needs fulfillment centres (i.e. logistics centres) in most, if not all, states. Even before this law was drafted, Amazon had been building a strategy towards this, so now Market Fairness has been signed into law, Amazon can suggest that it is pro-small business and publicly back the act. It is also notable that Ebay have publicly and vehemently opposed the act. Ebay’s business model will not adapt as well to Market Fairness as Amazon because many of its sellers benefit from the current lack of an equivalent to it. Unlike Amazon, they are unlikely to set up fulfillment centres in 50 states anytime soon.  Brian Bieron, the senior director of federal government relations at Ebay said, “putting a sales tax burden on that kind of business will make it harder for them to grow. .. there was a time when all of today’s online retailers were small businesses.”

What are the benefits of the law? How and why has it helped?

Primarily, the tax will benefit the income of those states that have less e-commerce businesses. A paper by Hawkins and Eppright (2000) quotes Forrester Research as saying these states are Florida, Illinois, Michigan and Pennsylvania with losses of tax revenue of between $18 million and $33 million per state. Given the meteoric rise of e-commerce in the intervening period, it is safe to assume.

A Financial Times article (Barber, 2013) puts the total sum of the currently uncollected taxes that will be gained by state and local governments at $11 billion. Others put the figure at closer to $23 billion. Bricks and mortar retailers have long complained that the lack of such a law gives online retailers a clear advantage. The lobby group for Marketplace Fairness is considerable and includes 97 members of Congress, 26 Governors and 343 organizations of various magnitudes.(see: http://www.marketplacefairness.org/support/)

Baugh et al (2014) provide figures for the projected increase in sales experienced at bricks-and-mortar retailers as well as rival firms to Amazon (effectively Amazon Marketplace merchants) as a result of implementing an online sales tax. They suggest that such an Act would lead to a 2% increase in sales in bricks-and-mortar and a 19.8% increase in the online operations of rival online operations. In the same paper, the authors show that an online sales tax led to a decrease in sales of 9.5%. Amazon’s revenue generated in the United States in 2013 was $44.5 billion. If we were to apply Baugh’s (2014) figure to the 30 states where Amazon doesn’t pay sales tax, the resulting loss in revenue would be in the region of $2.5 billion (44.5 x 30/50 x 9.5%). Amazon’s total sales are expected to reach $100 billion in 2016, and scaling this up from $74.4 billion in 2013 means that the loss in resulting revenue for the same period would be approximately $3.4 billion.

Finally, despite being a generally populist and bipartisan legislation, Marketplace Fairness will end up costing many consumers as well. A paper by Steel et al (2013) notes, “whilst consumers exhibit strong home biases, they will actively purchase goods out of state in order to avoid sales taxes.”

What pressures has it placed on the corporation?

Amazon has done much to oppose the deal, using its lobbyists in Washington DC to delay its implantation for as long as possible. However, in the past year, it seems to have accepted the inevitable: as one senator put it, “this isn’t a new tax, this is a due tax.”

Because the taxes are yet to be enacted on a state-by-state basis, it’s difficult to predict what effect the legislation will have on Amazon. Anderson et al (2010) estimate that implementing the sales taxes would lead to an 11.6% decrease in business, which is not too different from Baugh et al (2014) estimate of 9.5%. However, I would suggest that the price elasticity of consumers has fallen even in the 4 years since that paper. Einav (2012) seems to confirm this in a paper, which suggests the business decreases only by 3-4%.´

In a response to the act and the actions of its competitors, Amazon has begun a fulfillment centre strategy. Since 2010, a Bloomberg report (Kucera, 2013) notes that the company has invested $13.9 billion in logistics such as warehouses and other fulfillment facilities. This investment is more than Amazon had previously invested on fulfillment in its entire lifetime. It effectively means that Amazon can deliver to customers on the same day an order is made, often within a couple of hours. When the strategy is implemented, it will reach 50% of American households within one day compared to 15% now.

This strategy is expensive and thus, risky but the Marketplace Fairness Act is thought to have convinced decision makers at Amazon that it was necessary. Amazon management is considering the fulfillment centre strategy as a way to gain an advantage over competition after they lost the sales tax advantage. The strategy will also come with benefits – the ability to provide same day delivery may be an important factor for some consumers and remote sellers will not be able to provide this service. Likewise, having a fulfillment centre in each state will ultimately lead to lower shipping rates.

What might be likely to happen to amend the law or change it in some way?

E-commerce is still a relatively new phenomenon and legislation is still coming to terms with it. The Marketplace Fairness Act will probably be an early iteration of a series of taxes implemented on online retailers coming down the line. Before this occurs, there may be some changes made to the existing version of the Act. One proposal, put forth by Esty (an online art retailer) and Ebay (a competitor of Amazon), is to raise the annual revenue threshold for those companies under the remit of the Act from $1 million to $10 million.

Summary and Recommendations

The Marketplace Fairness Act of 2013 seeks to abolish the advantage of remote retailers who don’t pay taxes in states where they have no physical presence (stores, representative offices, warehouses, etc.) and “level the playing field” for bricks-and-mortar retailers. It was passed bilaterally in the United States senate and is likely to be just one of many new pieces of legislation that are drafted to deal with the growing importance of e-commerce.

Amazon initially opposed all moves towards the legislation but perhaps sensing that it was moving towards a situation where they would be present in most or all of the states anyway, turned to vocally supporting the deal. Amazon and their chairman Jeff Bezos are probably expecting increased taxes on its sales further down the line and perhaps as a measure to influence public policy, Bezos purchased the Washington Post in 2013. For a company with heritage in lobbying politicians, the purchase could be useful for Amazon in the future if successors of the Marketplace Fairness Act are proposed in the senate.

In the short to medium term, Marketplace Fairness will lead to decreased sales and revenue for Amazon. The Act will lead to sales that would have occurred at Amazon shifting to Amazon Marketplace merchants (who are not subject to the sales tax if they have annual revenues of under $1 million) and bricks-and-mortar retailers. The Act will particularly affect Amazon in those states where the sales tax is higher and also on higher value purchases, where the dollar amount of the tax being implemented is greater.

Amazon has already made steps to counter the act with its fulfillment centre strategy, however. Realizing that it would be liable for sales tax in an extra 30 states to those it currently pays sales taxes in, the company appears to have taken the decision to adapt to that scenario. From just 2 fulfillment centres in Washington and Delaware in the 1990s, the construction of fulfillment centres has become a strategy in its own right for Amazon over the past number of years. The consensus view seems to be that the company will have a fulfillment centre in almost every state. In June 2014, it was thought that Amazon’s fulfillment centres in the United States alone already compromised 43 million square feet (Wulfraat, 2014).

This strategy will be one of the means by which it will reinforce its dominance over bricks-and-mortar retailers and online competitors, despite the introduction of the Marketplace Fairness Act and the resulting loss in revenue. The Marketplace Fairness Act is likely to prove more of a temporary safety net for bricks-and-mortar businesses unless the online spending habits of American consumers that have been outlined can be reversed. The act, if fully enacted, will undoubtedly materially affect Amazon in the coming years but Amazon will adapt and ultimately, become a stronger company.

Bibliography

Journals and Working Papers

Anderson, E.T., Fong, N.M., Simester, D.I., Tucker, C.E. (2010). How Sales Taxes Affect Customer and Firm Behavior: The Role of Search on the Internet. Journal of Marketing Research, 47, pp. 229-239.

Baugh, B., Ben-David, I., Park, H. (2014). The “Amazon Tax”: Empirical Evidence from Amazon and Main Street Retailers. Fisher College of Business Working Paper 2014-03-05. April 2014.

Einav, L., Knoepfle, D., Levin, J.D., Sundaresan, N. (2012). Sales Taxes and Internet Commerce. NBER Working Paper No. 18018. April 2012.

Hawkins, R.R., Eppright, D.R. (2000). Proceedings. Annual Conference on Taxation and Minutes of the Annual Meeting of the National Tax Association. Vol. 93, pp. 45-52.

Steel, W., Daglish, T., Marriott, L., Gemmell, N., Howell, B. (2013). E-Commerce and its effect upon the Retail Industry and Government Revenue. Institute for the Study of Competition and Regulation. Paper ID: ISCR-2013.

Websites

Barber, L. (April 24, 2013). US online sales tax: Congress should end unfair advantage for interne retailers. Financial Times. Retrieved 2^nd July 2014 from: http://www.ft.com/intl/cms/s/0/e52117a4-ace8-11e2-9454-00144feabdc0.html#axzz36FFoanMD

Helm, B. (April 23, 2013). Not so fast congress: Online retailers push for changes to Marketplace Fairness Act. INC.COM. Retrieved 4^th July 2014 from: http://www.inc.com/burt-helm/state-sales-taxes-why-me-marketplace-fairness-act.html

Johnson, B. (February 14, 2013). Amazon backs new move to end tax break. Financial Times. Retrived 1^st July 2014 from: http://www.ft.com/cms/s/0/3c69bd6c-76d5-11e2-b925-00144feabdc0.html#axzz36FFoanMD

Kucera, D. (August 21, 2013). Amazon ramps up $13.9 billion warehouse spending spree. Bloomberg. Retrieved 4^th July 2014 from: http://www.bloomberg.com/news/2013-08-20/amazon-ramps-up-13-9-billion-warehouse-building-spree.html

Rawlings, R. (June 26, 2013). Let’s (not) panic about the online sales tax. Huffington Post. Retrived 1^st July 2014 from: http://www.huffingtonpost.com/rory-rawlings/lets-not-panic-about-onli_b_3467374.html

Wulfraat, M. (n-d). Amazon Global Fulfilment Centre Network. MWPVL International Supply Chain Experience. Retrieved 4^th July 2014 from: http://www.mwpvl.com/html/amazon_com.html