As Amazon.com and other online retailers retaliate against states that are trying to force them to collect sales tax, one of the big unanswered questions is how the issue will play out in California. California and a number of other states have looked at making Amazon and other web retailers collect sales tax by classifying them as physical retailers through their relationship with locally-based affiliates who link to Amazon websites. Amazon has yanked affiliate programs in other states to avoid having to collect sales tax, and warned California it will do the same there if tax legislation there gets approved. Now, prompted by Overstock.com's decision to sever ties with its California affiliates, Gov. Arnold Schwarzenegger is trying to hold the line.

Here's a statement from Schwarzenegger Wednesday:

Following Overstock.com’s announcement that it will pull its affiliate advertising from California due to the legislature’s proposal to increase taxes and the announcements of other companies such as Amazon.com threatening to follow suit, Governor Schwarzenegger today reiterated his deep commitment to not raising taxes to solve our state’s budget deficit and announced Overstock.com will reinstate California-based internet affiliate advertisers:

“After passing the largest tax increase in California history, it makes absolutely no sense to go back to the taxpayers to solve the current shortfall - that’s why yesterday I vetoed the majority vote tax increase passed by the legislature. With unemployment at an all time high, we should be doing everything we can to - keep jobs and create jobs - in California. That is why my Administration immediately contacted Overstock.com when we learned of this news and, I am pleased to announce Overstock.com has reversed its decision and will continue to do business with affiliates here in California. I will continue to fight to keep jobs and businesses in California.”

California lawmakers proposed a tax on affiliate advertising and sent legislation to the Governor, but as promised he vetoed it because we cannot solve our budget deficit by raising taxes and driving businesses out of the state.

Overstock.com estimates its internet affiliate advertisers in California create millions of dollars in revenue.

So far, Amazon's response in California is limited to a warning letter, but the online retail giant has cut off affiliate programs in North Carolina, Rhode Island, and Hawaii (Seattle online diamond merchant Blue Nile has done the same in all three states).

Is the brinkmanship working? In some cases, yes. Hawaii Gov. Linda Lingle has indicated she will veto the tax legislation that prompted Amazon to end its affiliate program there.

Amazon, of course, will continue to sell products in all states. Some suspect Amazon won't take much of a hit from ending its affiliate programs -- but it's apparently succeeding in raising the stakes for cash-strapped states hoping to tap online retailers for more revenue.

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