The most damning evidence against PP in my opinion is that they specifically stated (accordion to the author) that the same scheme was acceptable when raising money for a sick cat but not for needy kids. Unless the Regretsy folks were purchasing toys with a business account and skipping sales tax I don't understand the logic. The PP reps subsequent attitude seals the deal: eff PayPal. If he isn't authorized I dole out financial or legal advice regarding the use of the donation button or wrt raising money for needy kids he should just say that instead of being an obstinate jerk.
tldr: tax presumably was paid, PayPal rep is a scumbag, screw PayPal.