Amazon's looming state tax headache: Could Prime offset a worst case scenario?

Amazon's tax battle with cash-strapped states continues and the various skirmishes could take years to resolve. The big question is what happens to Amazon in a worst-case scenario where it has to collect sales taxes in every state.

First, let's recap the latest state tax issue for Amazon. Earlier this month, Amazon ended its affiliate program in Illinois after the state passed a law that would require the e-commerce giant to collect sales taxes on purchases by residents.

Under current law, Amazon only has to collect sales taxes when it has a facility, say a distribution center, in a state. State legislatures argue that an affiliate is a location. When a law passes, Amazon drops affiliates and the political battle continues.

Amazon calls these sales tax laws "unconstitutional and counterproductive" since they hurt small businesses (Amazon's affiliates). Amazon also notes that lobbyists backed by retailers are pushing these state tax bills. Amazon has threated to cut off affiliates in California and has already closed programs in Colorado, North Carolina and Rhode Island.

The Wall Street Journal on Thursday highlighted the Alliance for Main Street Fairness, which is pushing the state tax issue. The group has a series of blog posts blasting Amazon for avoiding state taxes. Some say that brick-and-mortar retailers are at a disadvantage due to the tax laws. Amazon obviously disagrees.

But let's fast forward beyond the politics and the play-by-play. What happens if Amazon loses the state tax battle?

For starters, Amazon's affiliate program ends. As noted previously, ending the affiliate program wouldn't hurt revenue.

The bigger issue is what happens when the prices on the street match what you get online. A Journal graphic illustrated how Target, Amazon and Wal-Mart pricing for electronic goods aren't all that different when you factor in sales taxes for all three retailers.

In many cases Amazon is still cheaper, but any shipping cost would probably make the company more expensive. If pricing were roughly equal against all online retailers the following questions about Amazon would be raised:

• Would convenience of Amazon be the tie-breaker?
• Does Amazon have the loyalty if it doesn't have an edge in price?
• How important are state taxes in the online buying decision?

I'd argue that Amazon would probably do fine even collecting sales taxes. Amazon has a loyal customer base as well as subscription buying that can acquire more consumer wallet share. The big unknown is that last question: Do sales taxes matter?

The answer: You bet. I grew up in Delaware---home of tax free shopping---and I still get angry paying a sales tax. Sales taxes stink a little less than ridiculously high property taxes, but you still notice the hit. All things being equal I'll buy a big item online if the shipping is free and the taxes are zilch.

Now if this state tax thing goes against Amazon, the big defense will be Amazon Prime. Amazon recently tossed in free media streaming to its Prime free shipping program. Rest assured, a free Kindle will be added at some point in the years to come.

Simply put, the more perks Amazon can add to Prime the more shipping becomes less of an issue. If Amazon can get revenue from Prime, offer free shipping everywhere and then be efficient enough to undercut rivals on pricing the state tax issue---assuming Amazon loses the state-by-state war---can be neutralized.

It's clear that Amazon has a state tax edge in most cases. If that edge goes away, Prime will become the new differentiator.

Related: Amazon vs. tax happy states: E-tailer could nuke Associates program and still win

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