Should Massachusetts Tax Netflix?

A bill introduced in the Massachusetts House, (H. 74) would expand funding for community media programming by imposing a new tax on the gross revenues of digital streaming service providers. The sentiment is understandable, but the proposed solution leaves much to be desired.

Municipally operated local access television channels, the no-frills stations residents can use to learn about community events, have traditionally been funded (at least in part) by fees imposed on cable service providers. As viewers shift their video consumption from cable-delivered content to that of streaming services (Netflix, Amazon Prime Video, etc.), revenue support for local media channels has declined. To compensate for that decrease, H. 74 would impose a 5 percent tax on the gross receipts collected by streaming companies from Massachusetts subscribers. There is nothing wrong with taxing the consumption of internet-based streaming services, but the method proposed in H.74 is seriously flawed. The preferred way to tax these services is to include them in the sales tax base. As proposed, the bill would tax the wrong entity, for the wrong thing, at the wrong rate, while violating the policy principles of neutrality and transparency in the process.

Why Cable Fees Should Not Apply to Streaming

H. 74 attempts to equalize the tax treatment of cable companies and streaming companies by imposing a gross receipts tax (GRT) on streaming companies that mirrors the franchise fee imposed on cable companies. Federal law, at 47 U.S.C. §542 authorizes localities to impose a franchise fee of up to 5 percent of gross receipts on cable service providers to compensate for their private access to public rights-of-way. The logic behind the tax is that cable companies profit from being allowed to install and maintain revenue generating fiberoptic or coaxial cables on or under public roads, lands, or utilities so they should pay a compensating fee to local governments. Setting the case for a GRT on cable companies aside, lawmakers’ attempt to extend that rationale to streaming providers is seriously flawed.

While streaming services do make use of certain rights-of-way in the delivery of their content, they often deliver that content through the same equipment the cable service-providers already paid the government for the privilege of installing. As we have previously observed in our analysis of taxes on streaming services, local governments contend that streaming services are a “utility” and subject to the same sort of taxes imposed on electric and telephone companies which, of course, rely on lines that run through public and private property and take advantage of governmental powers of eminent domain. But while streaming companies may piggyback on the cable company’s infrastructure, the cable company is already paying for the privilege of using those public rights-of-way. As we noted then, no one would suggest that a grocery store owner or his customer pay an additional transportation tax just to benefit from the services of a delivery truck that already paid fuel taxes and tolls to transport produce to the store on public rights-of-way.

Furthermore, a significant share of streaming content is delivered via cellular networks and signals which often do not rely on access to public rights-of way. To the extent streaming services rely on public utility infrastructure, they do not depend on it any more than non-streaming sites. Yet internet-based companies that make sales or deliver static content through the same transmission lines as streaming companies are exempt from the proposed tax.

If cable companies are concerned about streaming companies’ high bandwidth needs, that does not in itself necessitate government tax intervention. The cable companies can and do resolve business concerns with internet service providers through private negotiations. As we have written elsewhere, “streaming companies [already] pay the ordinary battery of taxes—corporate income taxes, property taxes, unemployment insurance taxes, [and] sales taxes on some of their business purchases…. Adding a streaming-specific tax or applying a right-of-way tax to streaming services simply because they are in competition with companies that use these rights-of-way has no real justification.”

Consumers Should Know They’re Paying the Tax

Second, H. 74 violates the policy principle of transparency in taxation. The bill requires that streaming companies remit the GRT to the Commonwealth, but the legislature is ultimately unable to dictate who bears the burden of the tax. Like the franchise fee imposed on cable service providers or 911 fees imposed on telecommunication providers, policymakers should expect streaming companies to pass the entire tax on to consumers. Market research shows that streaming services in general are mostly price inelastic, which means the number of streaming subscriptions consumers demand changes little relative to a change in price. A large part of this is likely due to the fact that consumers are unlikely to shift consumption elsewhere as the alternatives (satellite or cable services) still cost much more than the streaming service. Thus, streaming companies will likely succeed in passing along the entire tax to consumers. Although the bill avoids using this language, the end state is a thinly veiled tax increase on Massachusetts streaming service subscribers.

Treating Content Delivery Equally

If the Massachusetts legislature wants to promote neutrality and tax streaming services the same way as cable, the most appropriate way to do so is by including those services (and others) in the sales tax system—not by imposing a new GRT. Most states abandoned broad-based GRTs decades ago as they found them unequitable and economically damaging, taxing businesses’ revenues without any acknowledgement of costs or profit margin, and while GRTs still exist for a narrow range of activities, their expansion—especially to broad new services—is economically undesirable.

Conversely, there is no economic rationale that constrains a sales tax system to only physical goods. The ideal sales tax structure taxes a broad base of goods and services meant for final consumption (excluding business inputs) at a low rate. Streaming, satellite, and cable service subscriptions are undoubtedly purchased for final consumption. Although Massachusetts’ sales tax rate is currently 6.25 percent, it need not (and should not) remain that high if a wider range of consumer services are included in the base. In fact, the five states with the broadest sales tax base have an average rate of 4.475 percent. If Massachusetts levied that rate, it would have the eighth-lowest state rate and the second-lowest state and average local sales tax rate in the country.

Sales taxes are often criticized as a regressive form of taxation—one that taxes lower-income earners at a higher effective rate than higher-income earners. There is some truth to that claim, but primarily because higher-income individuals spend more of their incomes on services, which Massachusetts policymakers have broadly exempted from sales tax in the Commonwealth. The inclusion of a broad array of consumer services in the sales tax base would mitigate the regressivity of the sales tax and facilitate the reduction of the state’s sales tax rate—a policy change that would undoubtedly help lower-income earners and improve the state’s tax competitiveness.

When it comes to public finance, governments have the authority to collect taxes commensurate with the cost of funding the public goods and functions demanded by their constituents. But in a free market economy, governments also have a responsibility to exercise that power in a way that does the least amount of damage to the economy. To that end, tax policies should treat like-products and taxpayers the same. Governments should make clear when a tax is being levied and whom it is being levied on. Tax policies should not favor one group over another, and they should be easy to comply with and enforce. H. 74 is flawed in these areas.

The intent of H. 74 is to replace lost revenue for local access television stations by taxing streaming companies like cable companies for use of the public right-of-way, but this proposal forces a new industry into an old tax system and does so inefficiently. If states like Massachusetts wish to tax digital streaming and download services, they should do so by including them in their sales tax bases—preferably as part of broader reforms paired with commensurate rate reductions—rather than inventing new excise taxes or shoehorning the new economy into an antiquated tax system.