Online Media's Taxing Problem

There is a troubling trend of cities putting new taxes - so-called Netflix taxes - on streaming music, online gaming, ebooks, and online video distributors (OVDs) like Netflix, Hulu, and Sling. Pennsylvania, Chicago, and dozens of California cities have recently implemented or proposed taxes on online media. Yet there are several legal and economic problems with these taxes.

First, some of these taxes may violate the First Amendment since they single out certain types of media for taxation. Courts take a dim view of taxes that don't apply equally to all members of the press, and the U.S. Supreme Court struck down similar taxes in cases like Minneapolis Star v. Minnesota Commissioner of Revenue and Arkansas Writers' Project v. Ragland. Because they exempt similar media distributors from taxation, some of these new online taxes have severe constitutional deficiencies.

Second, the social costs for these taxes fall heavily on price-sensitive consumers and small online providers. Many subscribers use OVDs because they offer smaller, inexpensive TV packages. By "cutting the cord" and dropping traditional TV, they've already revealed that they are price sensitive, and taxing OVDs will only cause them to reduce their viewing. Further, small streaming providers will be hardest hit by these taxes when they are responsible for collecting the tax.

Determining where subscribers live and what taxes they are subject to is no simple task, either. It requires substantial legal and network engineering expertise to have systems that can identify user location, assess the appropriate tax, separate the tax from the subscription fee, and make the system accurate and auditable. This is a costly and complex endeavor for niche and foreign-language providers, like Crunchyroll (anime shows) and Spuul (Hindi films).

Finally, taxes fall inequitably based on business model and arbitrary classification. In Chicago, for instance, the tax applies when consumers rent an online movie for streaming, but not when they purchase an online movie for download. Cities are generally collecting from only online services that collect subscriber fees. This serves to penalize ad-free providers, like Netflix and Hulu No Commercials, and it benefits providers who choose to insert paid advertisements, like YouTube, Pandora, and Crackle TV. Such taxes incentivize services to rely on ads, not subscriptions, and - if streaming companies introduce more ads - they will reduce viewers' satisfaction with streaming services.

Online video and audio is a rapidly changing industry and will present cities and online companies with difficult classification problems. For example, are news organizations that charge subscription fees for traditional written news - but that also have substantial video libraries, like the Wall Street Journal and the Blaze - subject to these new taxes? Do Apple and Google now need to collect taxes on the video-on-demand services they offer in iTunes and Google Play? Amazon charges a fee for Prime, which includes not only its OVD service, but free deliveries, free ebooks, and music streaming. How much of the Prime fee is subject to taxation?

These questions will continue to pop up as online companies experiment with different business models. They'll also stifle online services that await regulator legal determinations, which will have perhaps hundreds of variations across the nation.

More than 100 streaming TV services launched in 2015. This is a dynamic and innovative sector that is giving American families easy access to mainstream and niche TV, radio, and games. This nascent industry and its subscribers should not be burdened with new taxes - especially taxes that will reduce entertainment options, be difficult to comply with, and be difficult to implement consistently.