Inside the Legal Challenge to Chicago's 9 Percent Netflix Tax

The city of Chicago has little to do with how its residents stream Netflix, Hulu, or Spotify, play Xbox Live, or use Amazon Prime. So why are its residents paying the city a 9 percent tax to use those services? A newly filed lawsuit may help determine whether cities have the authority to tax residents who cut the cord or otherwise use online streaming services.

In July, Chicago reinterpreted its "Amusement" tax to apply to "the privilege to witness, view, or participate in amusements that are delivered electronically," so long as the person is merely renting the content, which the city says is "normally accomplished by streaming or a 'temporary' download." Thus, the city became the first to try to create a new revenue stream from streamers.

The streaming tax is expected to bring in $12 million annually, according to the city. This tax is illegal, according to Jeffrey Schwab, an attorney at the Liberty Justice Center who is representing six plaintiffs who are suing the city over the new tax.

"Tax revenue from traditional television probably has gone down, and Chicago has a deficit it needs to make up, and the way it's doing that seems to be by making taxes on lots of little things," Schwab told me. "But the city can't just implement a tax without actually going through the city council and passing an ordinance."

Amusement taxes are quite standard throughout the country—they apply to things such as sporting events, live concerts, movie screenings and the like. In Chicago, the tax also applies to cable television, but does not specifically apply to the internet. Ostensibly, amusement taxes are there to help pay for city-incurred fees for holding events, such as police, cleanup, and in lots of cities, sports stadiums.

"If you go to a concert in the city, it's at least in the city. You have to take public roads or transportation to get there, you may need police in the area, there's a lot of services you can tie directly to the city," Schwab said. "That's not the case when you're streaming something on the internet."

Streaming, on the other hand, has little to do with Chicago, and nothing if you discount the fact that internet service providers need city permits and the like to deliver fiber or cable to residents' homes.

"The ordinance's imposition of a tax on amusements 'within the city' authorize a tax on video services streamed from the internet, which may be provided anywhere, to customers with residency or billing address in the City of Chicago who might use those services, partially or entirely, outside of the City," the lawsuit says.

The fact that Chicago has little to do with streaming content isn't the only legal question, however.

Schwab believes that the tax also violates the federal Internet Tax Freedom Act, which bars local and state governments from imposing "discriminatory" internet-only taxes. An analysis by the Reed Smith law firm also suggests the tax is illegal.

Schwab argues that the tax is discriminatory against internet services on a few counts. First and most obviously, the tax applies to Netflix streaming users but does not apply to Netflix customers who order DVDs through the mail. Secondly, Chicago's Amusement Tax code has several exceptions and loopholes for small music venues that have a capacity of less than 750 people. At those venues, you may pay a 5 percent per ticket rather than a 9 percent tax per ticket. If you were to pay to stream that concert online, however, you'd be forced to pay the 9 percent tax.

"This treats internet streaming media unfairly," he told me.

This may seem like a wonky, minor, and perhaps improbably case, but Schwab says he believes that, by challenging the tax, his plaintiffs are sending the message that they won't allow themselves to be taken advantage of simply because a city sees a chance for easy money.

"If Chicago can do this, then what about the other big cities and what about the states? It has a huge implication for companies, who may have to look at 50 or 100 different tax rates when it's thinking about pricing for customers," he said. "It also says that you can't just expand tax definitions to include something they never included before simply to avoid political controversy."

Schwab says that the case will likely take many months, and the Chicago government has already vowed to vehemently fight it.

"These things are exciting when they start," he said. "But there's going to be a lot of waiting."

280868771 Chicago Tax Complaint