Taxing the Internet

Numismatics_and_Notaphily_iconStarting on September 1, Chicago is trying something new and will be adding a 9% tax onto almost every service provided on-line. The city, along with the state of Illinois, is having huge budget problems and they are obviously leaving no stone unturned in looking to fill the tax coffers. But Chicago is the first local jurisdiction in many years that is trying to tax Internet-based services, something that will have wide repercussions.

So what are they trying to tax? The short answer is every information service that uses the Internet. For instance, the tax would apply to services that provide searchable databases—things like the LexisNexis system used by lawyers to find legal cases and precedents. As the data we use moves to the web this is a huge source of potential revenue for the city. Consider all of the services around today that charge people to access data. The Ordinance lists services like access to consumer credit reports, real-estate listings, car prices, stock prices, economic statistics, weather statistics, job listings, resumes, company profiles, consumer profiles, marketing data—any information or data that has been compiled, entered, and stored in a provider’s computer and then sold to others. The tax is also going to apply to taxable leases of personal property that include “cloud computing, cloud services, hosted environment, software as a service, platform as a service, or infrastructure as a service.

This tax does not apply to buying things over the Internet; it is not a sales tax on tangible assets, for instance, it would not apply to all of the physical products bought from Amazon. It would instead apply to companies like Netflix and Spotify and any other web service that sells electronic products. It would be up to the companies selling the onlune services to collect the tax and to remit the revenues to Chicago.

Obviously this new law will be challenged because it taxes a whole lot of things for the first time. It will also be interesting to see if this law is infringes on the protections provided several times by Congress in the Internet Tax Freedom Act as well as multiple times by the FCC, most recently as part of the Net Neutrality ruling.

But the city might have found a clever loophole. They are not taxing Internet access, but rather are taxing access to information and information services that happens to be stored somewhere else and then delivered over the Internet. It will be up to courts to sort out that nuance (or for Congress to pass a new law which is more specific).

One has to think that this law is very bad for businesses in Chicago. A 9% tax on anything is significant. Businesses spend huge amounts of money today on access to online databases and on cloud-based services that are moving their own information to the cloud. In effect, this law would tax companies for accessing their own data that they have chosen to store somewhere other than at their own business. I would not be surprised if this law drives businesses that spend heavily for such IT functions out of the city.

This also affects most people who live in the City directly. Almost everybody today who has an Internet connection buys some service over the web, be that a movie service like Netflix or Amazon prime or a music service like Spotify or Apple.

This kind of tax potentially adds a lot of cost for on-line service providers. Every town, county and state in the country has a different basis for assessing sales and service taxes like this one, and so this is going to require companies like Spotify to incorporate the tax assessment and collection process when they sell a subscription – something they don’t do today.

One would think that there will be a lot of avoidance of such a tax. It’s not hard for a business with multiple locations to be billed from a location that doesn’t get the tax. And since most on-line services don’t verify people’s addresses, somebody living in Chicago could most likely avoid these fees just by telling a Spotify that they live somewhere else. It’s hard to think that the City is ever going to be able to dig deep enough into online transaction to ever audit this.

But the real issue is not how the people in Chicago will deal with this. I am sure people and businesses there will take steps to avoid the new taxes if possible. The bigger issue is that other localities will copy the Chicago example if this holds up in Court. There is an old maxim that politicians have never seen a tax they don’t like, and so its not hard to foresee this tax spreading all over the country. And that is going to add costs to the online services we buy today, and since more and more things are migrating to the cloud this will become even more significant over time.

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