Mayor Brandon Johnson’s administration has been hunting frantically for politically palatable tax hikes to replace the $300 million property tax increase Chicago aldermen rejected unanimously last week.
One of the heftiest proposals on the table is an increase in the personal property lease tax on cloud computing — bear with us, we’ll explain what that is in English — which the mayor’s office says would raise $128 million annually. That’s an enormous sum of money, so our curiosity was piqued.
Who would pay that? And what would be the impact?
This levy effectively is a city sales tax on what businesses pay to license cloud-based software, a critical tool for virtually any modern office. It turns out that this tax, which at the current 9% could well be the nation’s highest on this essential service, behaves like a per-employee tax on all but the smallest of businesses located in Chicago.
The mayor’s office wants to hike the exorbitant existing rate to 11%, exceeding even the absurdly high 10.25% sales tax ordinary Chicagoans pay on most purchases. If the City Council approves the increase, the risk is that more than a few of the professional-services firms that have been the source of much of the city’s job growth over the past few decades may well view this measure as the final straw and simply move some or all of their operations out of town.
They won’t have to go far if they opt to vamoose. Chicago’s suburbs generally don’t tax business licensing of cloud-based software.
By way of background, Chicago is one of a very few cities in the U.S. to impose a sales tax on businesses’ use of cloud-based software, which powers many basic computerized functions of day-to-day work life — email, accounting and the like. Some states (not a majority) do so, although not at rates anywhere near Chicago’s. The state of Illinois taxes business licensing of some software, but the types of transactions the state targets aren’t nearly as expansive as Chicago’s.
The city has taxed computer services for business in some form or another for three decades. For the early part of that period, the tax was reasonably straightforward. The 21st-century advent of the cloud, which enabled software licensors to serve customers without need for downloads or other tangible methods, complicated matters. The city applied the tax to the cloud beginning in 2015. Initially, the rate at which Chicago taxed cloud-based software was lower than other software methods, but it wasn’t long before the city applied the same rate to all software licenses. The city increased the rate to 9% from 7.25% in 2021, not coincidentally the last time the city faced a budget shortfall of more than $1 billion.
It’s not surprising that mayors turn to this tax in times of budgetary stress. The levy is hard to understand, and isn’t nearly as high-profile as the hated property tax. It’s easy for increases to fly under the radar.
For the city, however, the problem with turning to this source of revenue time and again is that businesses can reduce the cost of the levy simply by moving employees out of Chicago. Why? When a business has Chicago as its billing address, the city’s tax collectors assume all of its workers are here and impose the 9% tax on the full cost of its software services. But businesses can reduce their tax bill by demonstrating to the city that only a percentage of its workers are in Chicago.
So, for example, if a business with a Chicago billing address employs just 25% of its workforce in the city, it has to pay taxes to the city on only 25% of its software costs.
In other words, there’s a built-in incentive for companies doing business in Chicago to move their workers to the suburbs if this tax becomes sufficiently onerous. Such moves are a hassle both to employers and their workers, but in an era of remote work that hassle is reduced.
Is 11% high enough to prod Chicago companies to consider a suburban move? Inertia is a powerful force, but we think 11% would start getting the attention of many a chief financial officer.
“In my experience, companies will consider leaving the city of Chicago if it means not being subject to a tax that’s such an outlier,” Samantha Breslow, a tax attorney with Kirkpatrick Townsend & Stockton specializing in state and local tax matters for businesses, told us Wednesday.
In our discussions with business representatives around town, word seems to be getting out slowly about this potential $128 million revenue grab at the expense of their constituents. Maybe they should think of the issue this way: Would a revival of the so-called head tax, the per-worker levy the city used to impose on businesses until Rahm Emanuel ended the job-killing practice more than a decade ago, get their attention more quickly?
The cloud-based software tax is a not-so-distant cousin of the head tax. The city’s business community ought to treat it as such and make their voices heard. Thus far, the floating of the software-tax hike has been met with nary a public word from detractors that we’ve heard.
Brandon Johnson has spent far too much of his mayoral term obsessing over where to find more money to finance his progressive agenda. He and too many of his aldermanic allies have ignored a deteriorating business environment that’s at the root of their fiscal woes.
A confiscatory tax on an essential tool for modern business only will further fuel the economic headwinds afflicting Chicago. Aldermen should kill the increase, just as they did the $300 million property tax hike.
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