Chicago's 'Cloud Tax' Could Help Netflix, Drive Others Out Of City

Chicago's so-called 'cloud tax,' which took effect this week and could charge consumers and/or businesses as much as 9 percent, is the first tax that specifically targets cloud-based companies.

Any service -- from Netflix, Inc. NFLX and Spotify to AWS from Amazon.com, Inc. AMZN and Apple Inc. AAPL's new music app -- could be impacted by the tax.

Hunter Newby, CEO of Allied Fiber (an open-access, integrated, network-neutral colocation and dark fiber superstructure), told Benzinga that this may have come from the same world as Net Neutrality.

"I believe that what happened was Netflix wanted protection from being mercilessly extorted by the Comcast-types," Newby explained. "The trade-off was to support Net Neutrality and allow the cities to tax the people, thus shifting the monetary burden to the tax payers and away from Netflix itself in the form of having to pay the access providers ever-increasing rates. The government will now enforce Net Neutrality, and through that, they get tax revenue. No sweat for Netflix as it isn't their money and now they have found a way to pay for 'protection.'"

Things aren't that simple, however.

"The technical reality is that the cloud servers will just move out of Chicago to avoid the tax and the people living in Chicago may, in an extreme case, leave Chicago for a tax-free cloud city," Newby added.

Related Link: Is Netflix Essential To The Future Of Pay-TV?

'Huge Advantage'

IT security expert Aaron Ross told Benzinga that he expects most of these companies to swallow the tax. He said consumers will be impressed by this, but warned that it will "eventually" result in a "higher fee."

"This might turn out to be a huge advantage to the larger companies, since they can afford to swallow the tax," said Ross, who owns cloud computing company Ross Backup. "I'm pretty sure that Spotify, Netflix and Amazon can cover it easily. The smaller companies might lose out, which might signal their eventual demise. Chicago might actually end up helping the larger companies."

Telecoms may also be impacted by the tax.

"They have a lot more to lose so they're probably watching with baited breath to see the reactions," said Ross. "We'll have to let this one play out for a few weeks."

Will Other Cities Follow Suit?

"They'll probably wait and see the reaction," said Ross. "If it works well, they certainly will."

In that scenario, Enderle Group principal analyst Rob Enderle expects the new tax to go national "real fast."

"Except for places that don't have sales tax, like Oregon," Enderle told Benzinga.

Ross said that if there is a "serious backlash" in Chicago, other cities and states "will look for other sources of revenue."

Consumer Workarounds

Newby said there are workarounds for those who don't want to pay the tax, such as a "VPN tunnel to Netflix over the Internet."

"One hundred million-plus people in China do it every day to get to the 'real,' uncensored Internet," Newby said. He also theorized that a new service/app will emerge "that allows people to sign up through it for Netflix (and other OTT services)."

"The app will use an out-of state, or even country, address (like a P.O. Box or Cayman Islands location, etc.) as the end user address for Netflix," Newby explained. "Netflix won't assess the tax on that account. There are plenty of legit ways around it. Technology change is occurring and the money flows are changing with it. Trying to stop it with old methods is ultimately futile and will only accelerate the demise of the incumbency."

Disclosure: At the time of this writing, Louis Bedigian had no position in the equities mentioned in this report.