A Democratic budget package approved by the state legislature last week has rekindled the nationwide debate over state regulation of internet-based retailers. The so-called “Amazon Tax” has made it to Governor Jerry Brown's desk and supporters of ABX1 28 say that his signature will “level the playing field” for brick-and-mortar retailers whose prices are undercut by online stores that do not charge for sales taxes.

In order to meet the June 15th budget deadline, state lawmakers have passed a series of bills backed by the majority party. Two main budget bills were promptly vetoed by Governor Jerry Brown who called on Republicans in the Legislature to "join Democrats in supporting job creation and ending tax breaks for out-of-state companies." Whether or not ABX1 28 would further this goal is up for debate.

The bill, a budget trailer that has so far survived a veto, merges three separate measures carried by Democratic lawmakers. If signed by Brown, it would force online retailers such as overstock.com and Amazon.com – who operate through a supposed “business nexus” with marketer affiliates located inside California – to charge a state sales tax on their merchandise. Current California law allows the Franchise Tax Board to levy a “use tax” on goods that are used within the state, but purchased from an online retailer not based in California. However, few residents follow the mandate to report untaxed, online purchases on their state income taxes.

In all, 14 states have on their books or are considering laws to force out-of-state retailers to collect a sales tax, but nowhere have these measures provided added revenue and all are coming under increasing legal scrutiny for implying that states have the power to regulate interstate commerce. The Supreme Court has already ruled in 1992 that states cannot require a business to collect sales taxes if said business does not maintain a physical store within state lines. California lawmakers hope to circumvent this decision by extending the tax nexus to affiliate partners – in-state websites that help drive traffic to retailers. But their plan might backfire.

     "What these legislators don't seem to understand is that in every state that's enacted such a law, we have discontinued our relationship with our affiliates and it hasn't affected our business at all," said Mark Griffin, vice president and general counsel for Overstock.com. "It's unfortunate that some of them go out of business, but these lawmakers are putting us in a position where we have no choice. We understand the difficulty it creates for our affiliates, but it's not a difficult decision for us to make."

Can we expect Amazon to sever ties with its California marketer affiliates like it did in Connecticut and Arkansas after those states passed nexus tax legislation? According to some retail and marketing groups, the answer to that question is an emphatic (albeit unenthusiastic) 'yes'.

The Performance Marketing Association (PMA), which has filed a lawsuit in Illinois challenging a similar law, said in a press release opposing ABX1 28 that the tax bill:

     “will simply not address the budget deficit because it will terminate relationships with 25,000 California Affiliate Marketers, along with putting the growth of startup companies and venture capital projects at risk.”

According to Keith Posehn, CEO of the San Diego-based mobile and social application company AppZorz:

      "Internet nexus tax bills, such at ABX1 28, needlessly endanger the growth of our state's tech startup community; several investors we've pitched to during our fundraising have openly questioned the wisdom of staying in California."

The estimated benefit of $195 million in retail-based revenue that ABX1 28 is supposed to provide for the state in 2011-12 (a drop in the bucket as far as California's budget shortfall is concerned) would have to be weighed against the cost of stranding thousands of affiliate marketers who would likely have to close up shop because of the legislation. Last year, these affiliates paid over $150 million in state income taxes. This lost revenue would have to factor into the debate, opponents argue.

Still, Betty Jo Toccoli, president of the California Small Business Association, told the San Jose Mercury news that most small businesses in the state are in favor of the law.

     "A jeweler in San Jose told us how people come in and look at the diamonds and the watches then go and buy them online to avoid the sales tax," she said. "It's just not fair."

One thing remains virtually certain.  As long as the burden of much-needed austerity and pension reform measures are indefinitely shifted to future budget votes, not even the most egalitarian of taxing structures will cover the the state's massive debt liability.