California’s New Law and the Effect on California/ STH
As a lot of people know at this point, Amazon.com has terminated all contracts with affiliates in California. That decision, in response to the new California law will have a negative impact on this site. For those wondering, on 28 June 2011, the state’s legislature incorporated an online sales tax as part of the passed budget. The next day, 29 June 2011, California’s Governor Jerry Brown signed the relevant bill into law, taking effect immediately.
The law basically had the effect of looking to expand the definition of a physical presence within the State of California. This is a legal term of art that is in response to a 1992 United States Supreme Court decision that outlined a requirement that a state shows that a retailer has a physical presence within the state in order to collect taxes. Companies like Overstock.com and Amazon.com that are big Internet retailers not headquartered in the Silicon Valley, San Francisco, or the Los Angeles area have been exempt in most cases from collecting California sales tax due to this decision.
Affiliate programs are fairly simple. Sites use links that can be tracked by retailers that link to products found on the retailer’s site. If a user purchases a product after clicking on the link, a referral fee is paid usually ranging from 0.5% to 4% of item value (some, of course, pay more and less depending on the product purchased.) This type of advertising is prevalent in just about every industry and medium in some form. In the internet retailer context, it is just called affiliate marketing.
On a micro level, this site has used the Amazon affiliate program to generate a decent amount of revenue used to do things like purchase new hardware to review and keep the server/ domain name up. The fact that Amazon.com has severed relationships with affiliates is something I completely understand, but will have a negative short-term impact on the site as it will be harder to purchase hardware to review.
On a macro level, it is fairly amazing that enough people thought this was a good idea to actually sign it into law. As the law was signed, Amazon and Overstock terminated affiliate relationships immediately. The $200 million to $300 million that the law was expected to bring in, will go uncollected. California’s lawmakers had reason to know that this would happen as the companies stated as much, and Amazon has pulled out of at least five other states in a similar manner.
So after millions of dollars spent on getting the law passed, it will likely realize very little, if any of the tax revenue envisioned to balance the budget thereby instantly putting California at a shortfall. The effect will run much deeper though. Companies that rely upon affiliate advertising will leave the state. Bloggers like myself may do the same, but many will stay and be forced to find other, less lucrative forms of income.
Now here is the kicker, affiliate advertising extends beyond California’s borders. If a California affiliate refers a user in Oregon to purchase something from a Washington based company, the affiliate makes money and reports income, in California. Given California income taxes, let’s assume that California gets 10% of the commission earned in taxes, and let us assume a 4% commission. Prior to the law’s passage, California was effectively taxing interstate commercial transactions that did not occur within its borders taking 0.25% of the transaction value. Now that these companies have pulled out of California, the state loses not only transactions that occur with people within its borders, but also between residents of other states.
Furthermore, other affiliates may not be able to attain the same income level post-Amazon.com pull-out, because most users will gravitate to the highest income for their efforts. This lost income again will lead to lower taxable income for the state and has the potential to cause job loss, something that any city-state with ~9% unemployment should not look to do.
As a recap, California Governor Jerry Brown, along with the California legislature passed a law to balance a budget that they knew would not meet projections at the time of signing. The law caused large affiliate program operators such as Amazon.com to close the programs in the state. The net effect will be lost jobs, and net negative tax revenue due to lower income and decreasing the state’s reach of pseudo-taxable transactions. As for this site, luckily it did not make much anyway so there should not be a very noticeable impact 🙂 On the flip side, there is a possibility I take my taxable income stream to another jurisdiction capable of not making implosive decisions.