Will Cities Increase the Cost of Internet Services?

Why do city officials raise taxes? The answer, in some cases, is as simple as “because they can,” or at least they think they can.

In recent weeks, a number of California cities announced plans to extend their utility user tax to media streaming subscriptions and online rentals. So, if you subscribe to Netflix, Hulu, Amazon Prime, HBO Go, Sling TV, etc., your bill could soon increase by the amount of your city’s tax. Utility user taxes average about 6% but are as high as 11% in some cities.

If you don’t remember voting to tax Internet services, you’re right. Then why do these cities think they can get around Prop 218, the Right to Vote on Taxes Act?

Around 2006, thanks to lawsuits and demand letters from the Howard Jarvis Taxpayers Association, most cities were forced to put revised utility user tax ordinances on the ballot if they wanted to tax cell phones. Such revisions redefined not only “telecommunications” but also “video services” to reach beyond cable TV. To win passage of these broadened definitions, most cities hitched them to a small rate reduction which fooled voters into thinking they were approving a tax cut rather than a tax increase.

That brings us to today. Just as people traded in their land lines for cell phones in the early 2000’s, today people are switching from cable TV to online streaming services. And, as before, cities fearing a loss in revenue want to tax the new technology.

Citing the broad definitions accepted by voters who thought they were approving a tax reduction, city officials claim they need neither an amendment nor additional voter approval to extend the tax to Internet services.

The Howard Jarvis Taxpayers Association disagrees for several reasons. First, we believe Congress has adopted strong protections for a free Internet that forbid state and local governments from taxing Internet content.

The Internet Tax Freedom Act prohibits state and local governments from taxing Internet access or imposing “discriminatory taxes on electronic commerce.” In this case, cities are singling out online services that have a billing system already set up to collect monthly subscription payments or one-time rentals. The reason is obvious: convenience for the city. All the city need do is send out a notice, and these service providers become responsible for calculating the tax, collecting it, and remitting it to the city.

Paid online providers, however, are not the only source of similar goods and services. There are several free online services like Crackle and YouTube. Because the proposed utility user tax extension applies only to select paid online services, the tax discriminates against certain electronic commerce and therefore violates the Internet Tax Freedom Act.

The second legal problem facing cities is that, in most cases, the services they want to tax do not have a “substantial nexus” with the city. The U.S. Supreme Court coined that phrase in ruling that a seller can’t be taxed by a jurisdiction unless that seller has some physical presence in the jurisdiction.

In the case of Netflix, for example, it does not provide the equipment viewers use to access or watch its content. Netflix does not own the cables or transmitters through which third parties deliver its content. Netflix has no office, store, or employees in most of the taxing cities. Without any physical presence there, these cities have no basis for reaching outside their borders to exercise their local taxing authority.

The Howard Jarvis Taxpayers Association is committed to protecting its members and the citizens of California from illegal taxes. We will be closely watching these proposed utility user tax extensions to see whether litigation is warranted.

Jon Coupal is president of the Howard Jarvis Taxpayers Association — California’s largest grass-roots taxpayer organization dedicated to the protection of Proposition 13 and the advancement of taxpayers’ rights.