I read somewhere that it was related to tax optimization. That is, if you sell a book from California, you have to apply state tax to California residents (38M) but if you sell it from Washington, you don't. So the fact that Washington had fewer potential customers than California (or New York, where Jeff Bezos was working previously), meant a smaller tax bill for its country-wide customer base.

I've heard this also, and it makes sense. Although Amazon is now finally going to charge sales tax everywhere, it undoubtedly helped their growth that they could undercut others in large markets like NY and CA by not charging sales tax. I'm sure this wasn't the only factor, but if it meant a 9% pricing advantage in CA, it could have been a real consideration.

They also sold under MSRP since their product was basically virtual (aka just in time).

In the book, The Everything Store, the writer tells about Bezos intentions for Washington. It was combination of fewer customers there and a close distance to a large book publisher, there were a few other smaller accompanying reasons like another poster mentioned about msft being in the area as well.

That is the same reason many Seattle startups picked being in Seattle. Software engineers, cost efficient to run a startup (office space), a great startup ecosystem, 2 hours from the valley, and decent ability to raise capital.