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By Daniel Salvaterra

North Carolina is a state with a huge budget deficit. It is one of the worst state deficits in the nation at $4.6 billion or 21% of the general fund budget for fiscal year 2010. In addition, North Carolina has the 5th worst unemployment rate in the country at 11.1%, and just missed the top 10 lists of the worst states in the country for business (39th here, and 38th here).

So how has the Tar Heel State proposed it solve its budget crisis and spur economic growth? Not by cutting spending of course! Governor Beverly Perdue has proposed $1.5 billion in tax increases, much of which will come from taxing online retail sales from companies that have no physical presence in the state.

The so-called “Amazon Tax” has been sparking intrigue from a number of states facing budget problems since being passed by New York in 2008. Since then, California, Hawaii, and North Carolina have all pushed forward similar taxes in an attempt to raise revenue to offset each state’s irresponsible spending habits. The tax attempts to get around the interstate commerce clause in the Constitution that carries the implication of a “physical presence” standard. Essentially, a company must have a physical presence of operation in the state in order for the state to be able to charge the company a sales tax. There is currently a bill before Congress that would make law a uniform physical presence standard.

The desperation of states like New York, California, and North Carolina to raise tax revenue so they can fund entitlement programs has led them to target affiliate marketers for online retailers like Amazon and Law makers are saying that affiliates who reside in their state represent the physical presence needed to be able to tax online retailers the affiliates work with even though the affiliate is not owned by or an employee of the company they refer sales to.

Affiliate marketing companies come in all shapes and sizes, but for the most part they are small businesses that refer sales or leads to online retailers in return for some kind of commission or bounty. Affiliate marketers use both online and offline strategies to refer consumers to online retailers’ websites either through a Web link, a special URL, or a specific code that identifies to the retailer that the sale came from a specific affiliate. While there are many forms of affiliate marketing business models, the one thing they all share in common is that they can operate from anywhere in the world. That is until now.

With the introduction of the Amazon Tax, affiliate marketers in New York and perhaps soon in California, Hawaii, and North Carolina are being terminated from or not allowed into affiliate programs of companies like who would rather take a pass on sales generated by affiliates than collect taxes for states were they do not reside. The actions taken by companies like Amazon have led to vetoes of such bills in California and Hawaii for the time being, while North Carolina persists.

Back in North Carolina, public schools account for $8 billion or 37% of their $21 billion budget. If this one expenditure were reduced by 6.8% they would have their $1.5billion to spend on other priorities. The governor, however, has said that North Carolina “cannot afford to gut education” like this despite proposing a 4.9% reduction in public school spending herself. The necessary cut is only 1.9% more than her proposal in this year’s budget.

So instead of angering the education lobby that helped her get elected, Governor Perdue is pursuing more taxes that will only cause further damage to North Carolina’s suffering economy. Amazon has already put affiliates on notice that they will be terminated once the law is enacted. This means that not only will North Carolina once again be unable to collect the sales tax from Amazon, but also now they won’t even be able to collect the income taxes from affiliates who profited from their relationship with Amazon in the past. That is a net loss in tax revenue resulting from a bill that was supposed to increase taxes by $1.5billion. In short it is a recipe for disaster.

The one benefit the Amazon Tax has brought about is a wonderful teachable moment on stupid tax policy. Conservatives have espoused for decades that raising taxes actually reduces revenue coming into a government, and the example of the Amazon Tax illustrates that point perfectly. States with serious economic problems right now should not be looking for more tax opportunities to artificially sustain bad spending habits. Instead they should take this time to prioritize their expenditures and make cuts where necessary.

The example of North Carolina can be very useful as a guide on what should not be done to recover from economic distress, and shows how everyone loses when the tax burden becomes too high. Amazon loses sales, affiliate marketers lose a source of income, and the state loses tax revenue.

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