Full of Hot Air? Municipal Governments Seek to Tax the Cloud

As bricks-and-mortar retailers close their doors, businesses rooted in e-commerce are booming. Companies like Amazon and Netflix evolved in the relatively unregulated space of the internet, and industrial-age tax codes aren’t yet equipped to properly harvest the revenue from them  to which they’re entitled. As a result, governments around the world are faced with dwindling revenues and are beginning to think seriously about how to make up the shortfall from digital transactions.

To that end, the City of Chicago has recently approved an “amusement tax” which aims to collect a 9% levy on entertainment offerings in the city. Unusually, the levy specifically includes entertainment offered digitally, including those provided by services like Netflix. This has led some observers to dub it a “cloud tax.” The law came into force on September 1st, and the city hopes to raise $12 million in additional annual revenue from its application. Some critics maintain that the new levy will harm Chicago’s reputation as an overburdened, tax and regulation heavy district, and dissuade digitally innovative startups from headquartering there.

The City of Chicago is not the only jurisdiction wrestling with the problem of extracting revenue from digital services.  Washington’s state legislature introduced a similar tax on digital content through legislation in 2010. Alabama has repealed similar legislation and Michigan is fighting in multiple court cases to keep its taxation scheme alive after citizens began filing lawsuits disputing the right to collect the tax under the Internet Tax Freedom (ITF) act of 1998.

While the right of the state to collect revenues isn’t under general dispute, many issues arise in the implementation of such taxation schemes. Legal frameworks born in the industrial age are increasingly struggling to encompass a society that is increasingly digitally native. Even before its implementation the legality of the city of Chicago’s tax was being questioned under Federal legislation like the aforementioned ITF and the Telecommunications Act. Detractors argue that any cloud taxes must be imposed by legislatures, and not as mere administrative decisions within municipal departments. Enforcement is also posing a difficulty. What is the cost of noncompliance? How does a municipal government effectively enforce such legislation and ensure its adequate collection, when the companies being taxed aren’t headquartered anywhere near its jurisdiction?
The challenge to government revenue posed by digital disruption is real, but stretching outdated laws to accommodate a fundamentally transformed environment may be an inadequate solution. Governments and regulators should rather be thinking about the big picture; what fundamental changes are necessary in their role to ensure fiscal viability in a changing world.

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*This research was supported by the Social Sciences and Humanities Research Council of Canada.