Taxing the Cloud: Chicago Decides to Tax Residents for Using Netflix

Can a city tax the cloud? Not the type of cloud in the sky, but the technological cloud. Netflix. Spotify. Pandora. Amazon. These companies have become massive suppliers of cloud-based media over the last several years. Millions of hardworking Americans have utilized these services in the names of convenience, on demand entertainment and even for business purposes.

In a quest to discover new streams of revenue, the city of Chicago recently announced a “cloud tax,” expanding the existing Amusement Tax and Personal Property Lease Transaction Tax to include online streaming and database services. From the city’s perspective, it is missing out on tax revenue that would otherwise be paid by customers of brick-and-mortar businesses. By using cloud-based platforms, the city believes consumers are not paying their fair share of taxes.

The Chicago Department of Finance has ruled the new application of these taxes to cloud-based services is appropriate as it taxes consumers of online services who live within the city limits. For example,

[S]treaming a movie, listening to streaming music, or playing a game on a smartphone or tablet will now trigger a 9% tax on the subscription charge for those services if those activities are done at a location in Chicago. Furthermore, the ruling addresses “bundled” transactions, by providing that “unless it is clearly proven that at least 50% of the price” is not for the amusement, the entire charge… is subject to the [9%] Amusement Tax.

The Personal Property Lease Transaction Tax applies a 9 percent tax to other cloud-based services that are not for amusement, such as commercial software and file storage services.

Physical stores, movie theaters and other brick-and-mortar locations brought the services now offered by companies like Amazon, Netflix and Hulu to market during the last few decades. These physical stores paid taxes on goods, services, property and employees. As the taxpayer opted to receive services in the convenience of his or her home through online services, Chicago witnessed some of its tax base decrease. However, cloud taxes will not solve Chicago’s problems; it will only exacerbate them.

The cloud taxes also raise interesting policy questions. For instance, if service providers such as Spotify and Pandora offer free and subscription services, will the hardworking Chicagoan be taxed for the free services, or just the paid subscription services?

Who is responsible for tracking the location and use of the services? Is a company like Amazon or Netflix supposed to monitor the taxpayer? Is the taxpayer supposed to self-report? What about visitors who may have accounts from outside the city, but decide to watch a television show on Netflix within the city?

Is this type of tax even legal? According to Reed Smith lawyers like Michael Wynne, there are “strong arguments that both rulings run afoul of provisions in the Federal Telecommunications Act, the Internet Tax Freedom Act, and federal and Illinois constitutional limits on taxation.”

Finally, if a cloud tax is widespread across all major cities, what impact would the tax have on innovation and competition? The incentive to create and offer such services would be diminished.  It would open the door to more government intervention and regulation in the entertainment and music service software industry.

Chicago’s cloud taxes violate several of ALEC Principles, including the Statement of Principles for Telecommunications Tax Reform and Principles of Taxation. These principles state that any tax should be both “revenue neutral” and “easy to administer and collect.”  Chicago’s cloud taxes represent a new stream of revenue, are neither easy to administer nor collect, and place substantial burdens on its taxpaying residents.

These cloud taxes also emphasize the need for a federal-state framework protecting consumers from multiple, discriminatory and inconsistent state and local digital goods tax laws. The ALEC Digital Goods and Services Tax Fairness Resolution calls for this protective framework.

The cloud taxes will do more harm than good. In addition to questionable legality, the taxes will harm already burdened taxpayers and stifle innovation.

In Depth: Cronyism

Cronyism in tax policy stifles innovation, hinders competition and introduces a deep temptation for corruption. The 2014 ALEC Center for State Fiscal Reform study, The Unseen Costs of Tax Cronyism: Favoritism and Foregone Growth, found that in the most recent year in which states published their respective tax expenditure…

+ Cronyism In Depth