It’s no secret the winters in Chicago are brutal—anyone who has lived through a January in the Windy City can attest to this fact. Long periods of Netflix-aided hibernation are common for Chicagoans in the depths of winter. This is perhaps why the news last month that city residents will begin paying a “cloud tax” on their monthly Netflix bill didn’t go over well. As more business activity migrates online and consequently outside traditional tax protocols, cities and states are being forced to modify their tax regimes to adapt to these changing circumstances. While governments are certainly justified in their concern about dwindling tax receipts, digital commerce is fundamentally different than traditional brick-and-mortar enterprise and requires a thoughtful, unique approach to taxation in order to properly protect public interests without stunting business growth. Unfortunately, Chicago’s approach to digital taxation appears to be precisely the sort of hastily considered, ad hoc policy that could end up doing serious harm to the digital economy.
The ruling from the Chicago Department of Finance imposes a 9% tax on “electronically delivered amusements,” defined as “any exhibition, performance, presentation or show for entertainment purposes.” Essentially, this means that any electronically delivered television shows, movies, or music consumed for rental by customers in the city will be taxed. Technically speaking, the tax itself isn’t “new”—rather, it’s an expansion of Chicago’s existing amusement tax which covers concerts, sporting events and other activities. The ruling requires online digital content distributors to collect amusement taxes for digital amusements. While other cities have similar amusement taxes for brick-and-mortar establishments, Chicago’s application of the tax to digital content distributors is novel.
Chicago realized the tax money it was collecting from brick-and-mortar enterprises like movie theatres and video stores was evaporating as consumers stopped frequenting such establishments in favor of Netflix and other streaming services. So what’s the problem if Chicago is merely taxing digital video rentals in the same way it had traditionally been taxing physical video rentals? For one thing, the ruling took most people by surprise because there was little if any public participation in the decision. Instead of passing a new city ordinance or going to the voters to approve a new tax—both of which would have involved robust opportunity for public comment—the Department of Finance chose to quietly broaden an existing law. It’s hard to imagine a similar tax policy with such a wide impact not being publicly debated. Sidestepping voter approval suggests (not surprisingly) that there may have been public opposition to the new tax.
Beyond the process questions this new regulation raises, it highlights a broader issue around taxation of digital commerce. While a local brick-and-mortar business only has to worry about complying with tax laws of the jurisdiction in which it operates, online businesses may be subject to taxation in any jurisdiction in which its customers reside—that is, anywhere in the US. For larger companies like Netflix, setting up the infrastructure to comply with a variety of tax jurisdiction is possible (though still expensive and onerous). For the small businesses that have historically driven the growth of the Internet economy, such compliance obligations would be insurmountable. According to the US Census, Illinois has 6,994 separate local governments. If each one chose to implement unique taxes on various internet goods and services, compliance would be significantly convoluted. For small businesses operating in an online marketplace with limited margins, such requirements could potentially put them out of business.
It’s no surprise cities struggling with reduced tax revenue are looking for new revenue streams. Indeed, discussion and action needs to take place around fair online tax policy, but it needs to take into account the uniqueness of the online environment. Chicago’s recent action highlights the need to have these conversations soon, and at a national level. Congress has put at least some effort into addressing the problem of e-commerce taxation, introducing the Marketplace Fairness Act three times, and discussing alternate proposals from Reps. Chaffetz, Goodlatte, and Eshoo. However, the current legislative climate—coupled with opposition from large Internet businesses—makes legislative action before the 2016 election unlikely. In the interim, other cities and states may follow Chicago’s lead, attempting to raise tax revenues in the short term, while jeopardizing the long-term health of the Internet economy.