Is the " Tax" Coming to California?

Image representing eBay as depicted in CrunchBase

Image via CrunchBase

I remember when I first heard, sometime around 1999 or 2000, that more than 10,000 Americans were earning their entire income using eBay. It was a revelation. Until that point, I didn’t realize how the new economy could create opportunities for individuals and small businesses to not just support themselves, but to thrive doing so.

Well, here’s another amazing statistic: In California alone, there are approximately 25,000 individuals who currently earn their incomes from ads on their websites. These are individuals who have websites that may be anything from personal blogs to online newspapers or newsletters, shopping comparison websites with coupons and money-saving tips, or other sources of information.

Known as “affiliate marketers,” these individuals earned $1.6 billion in advertising revenue in 2009, and they paid $124.5 million in California state income tax.

They’ve been a bright spot during an otherwise bleak economy. The advertising industry overall declined 18 percent during 2009 but advertising through online affiliates rose 1 percent — in spite of the major economic downturns.

Amazingly, these folks have figured out how to provide information and to earn a living, while at the same time traditional newspapers and media are suffering and losing ad revenue.

(For an example, check out the book ad in the right column. I sometimes have small, unobtrusive ads for books in the right column. If someone clicks through and makes a purchase, I get a small commission, which helps subsidize the cost of maintaining this blog.)

In short, affiliate marketing is an incredible success story in this difficult economic climate.  Unfortunately, the reality of the California state budget crisis may be threatening their success .

California lawmakers, like lawmakers in most states, are desperately hunting for new sources of revenue.  California is currently almost three months into the fiscal year without a budget.

Lawmakers are currently considering a tax called the “affiliate nexus tax” — also known as the “Amazon tax” for its impact on — which would tax out-of-state retailers who advertise on California-based or California-owned websites.  This could hurt the 25,000 affiliates right in their bottom line.

In a commentary in the California Weekly recently, Rebecca Madigan argued that taxing affiliates would be disastrous.

Madigan argued that the tax would result in out-of-state retailers terminating their California affiliates, and place their ads on affiliate websites in other states. Mom and pop websites that depend on out-of-state retailers advertising on their websites would lose their source of support.

She argued that the proposal:

has a design flaw that will threaten thousands of small California businesses, at the same time netting the state zero dollars in new sales tax revenue.

I suppose people will probably fall down on party lines on this proposal, as they typically do when it comes to tax issues.

My problem with Ms. Madigan’s argument is I don’t think out-of-state retailers will entirely terminate their advertising with California-based websites, especially if their advertising on the California-based websites has been successful.

The more likely scenario is if there were an affiliate nexus tax, it would mean California-based website owners would have to adjust their advertising rates. Take a simple analogy: a burger stand sells burgers for $3 which are wildly popular. All of a sudden the city starts charging a ten-cents-per-burger tax.  Customers won’t stop flocking to the stand, but they may grumble about the new $3.10 cost they’re incurring. If customers are really upset, the stand may have to adjust their price for a burger to accommodate for the higher cost.

Similarly, if a previously highly-trafficked San Diego-based blog charged $100/month for a banner ad, and the Legislature created a $10 flat rate tax, then the site could adjust by charging $90/month. The blog wouldn’t make as much money, and I’m not saying this is a good solution, but they wouldn’t necessary lose the advertiser entirely.

On the other hand, evidence has shown that the companies that advertise may play hardball and withdraw all advertising on California-based websites.

For an example, here’s a copy of an email from Amazon to a former Colorado-based affiliate after Colorado passed a similar state law. has also promised to terminate all California-based affiliate marketers if the measure were to pass.

The proposal is definitely not perfect, and there’s a risk it could lead to lower revenues.  These 25,000 affiliate marketers paid a lot of California state income tax during 2009. What if Ms. Madigan’s argument comes true, even in part? If out-of-state retailers withdraw from California-based websites but continue to advertise on sites located in different states, the state would not gain new sales tax revenue and it will lose some income tax.

On the other hand, there are serious Constitutional concerns. Under the U.S. Constitution’s commerce clause, only retailers who have a physical presence in California are required to collect sales tax. States cannot regulate or tax in a manner that would materially burden or discriminate against interstate commerce.  Where legislation effectively favors in-state economic interests over out-of-state interests, it has been held to discriminate against interstate commerce and is an illegitimate exercise of state power in violation of the dormant Commerce Clause.

The proponents of the so-called “Amazon Tax” argue that affiliate websites owned by California residents establish nexus for out-of-state retailers who advertise with them. It’s not clear if that argument will hold water.

Just because a retailer in New York puts an ad on a blog whose owner happens to live in San Jose, California doesn’t mean the New York company has a physical presence in California.

Another bigger concern is the impact on the new economy of affiliate marketing. This tax could threaten the industry. If there’s one thing we can agree on, it’s that in today’s economy, we need to do everything we can to support the few economic bright spots to thrive.

What do you think? Please feel free to leave your thoughts in the comment below.

(photo credits: Crunchbase;