When Illinois passed a bill this month that would force online retailers to collect sales taxes on goods sold in the state, it sparked more than just a war with online retail giant Amazon. The bill revealed a recession-fed competition among states that pitted the long-term revenue against the near-term desperation for jobs.
Across the country, states have been looking for any tax, incentive, or cut that could help bridge the growing chasm between resources and budget demands.
It has become clear in recent months that the recession may be over, but states still are a long way from fiscal stability. Analysts at the Washington-based Center on Budget and Policy Priorities say states will face a collective budget shortfall in excess of $112 billion in 2012. Illinois alone faces a gap of about $15 billion next year.
And the problem seems to be getting worse, so Illinois turned to a controversial tax measure that states like Colorado, New York, and North Carolina have tried.
The law will patch a loophole allowing online retailers to leave the sales tax off a shopper’s bill. For decades, Illinois residents were expected to declare online purchases when they file their income tax returns, so the state could then collect the tax. But that method failed.
“We lose $153 million a year from online shopping,” said Brie Callahan, a spokeswoman for Democratic Gov. Pat Quinn. “The burden was entirely on the taxpayer, and a lot of people don’t know about it. They don’t know they’re supposed to pay it.”
But lawmakers argue the bill only updated an old law that contained a costly oversight that grew larger each year.
A study by Forrester Research estimates that Internet sales in the United States could grow from $155 billion in 2009 to nearly $250 billion by 2014. Illinois needed a law that recognized a new economy.
But while Illinois was missing out on sorely needed income, Amazon, Overstock.com, and other online-sales behemoths created a new normal. Online retailers took advantage of their speedy growth to create a nationwide web of affiliated retailers. Those affiliates came to rely on the sales-tax break to drive down the price of goods sold online.
As a result, the rules for the Internet economy just weren’t the same as the rules for brick-and-mortar stores. Online shoppers could instantly compare prices between hundreds of different retailers and adding even a dollar or two in sales tax could price a seller out of competition.
By requiring retailers to tack on sales taxes to every online purchase, Illinois was essentially making it harder for companies like Rockford, Ill. (near the state’s border with Wisconsin)-based FatWallet.com to compete.
“My customers don’t care if we’re in Illinois, Wisconsin, or lower Uganda,” said FatWallet.com founder and CEO Tim Storm. “The reality is they just don’t care.”
Though Illinois has company in its battle to collect Internet sales taxes, companies like Amazon could easily move to more favorable climates in Wisconsin, Indiana, or Iowa.
And that’s just what they did. Within hours of Quinn signing the bill, Amazon and dozens of other retailers pulled the plug on affiliate programs, partnerships, and business relationships in Illinois.
“We’re looking at a hit of 30 to 40 percent of our revenue,” Storm said. “There’s a competition thing that goes well beyond whether I’m paying tax or not. All of the out-of-state retailers are canceling their contracts. All it is doing is driving our business out of the state.”
And now states have effectively been pitted against one another. Lawmakers are being forced to choose between collecting the taxes they are due and risking the loss of thriving companies—and the jobs and income-tax revenue they contribute—to neighboring states.
Though this battle between states isn’t new, fighting this battle in a gravely wounded economy could spell bigger trouble if states choose to focus on immediate outcomes instead of long-term revenue, according to Michael Mazerov, a senior fellow at the Center on Budget and Policy Priorities.
“This is a much broader issue given how terrible the job situation is in the economy and how desperate states are,” he said. “Corporations are increasingly aggressive and they have state and local officials over a barrel. They’re, unfortunately, increasingly willing to give tax breaks for a few short-term jobs.”
And states are desperate to keep jobs within their borders as nationwide unemployment continues to hover near 9 percent. But those states that offer tax breaks and incentives to keep companies happy may find themselves in a fiscal Catch-22.
Companies may be happy to accept tax breaks, but overburdened state budgets have been filling gaps by cutting from education, infrastructure, and development investments. If states divert funds from improving public education, maintaining roads for shipping routes, and investing in growth, companies may not be happy with the workforce available tomorrow.
“They’re seriously undermining their ability to provide long-term services by giving tax break after tax break to any corporation who is willing to play hardball,” Mazerov said. “They have to find a way to get off of this treadmill.”
This article appears in the March 28, 2011, edition of National Journal Daily.