The 2012 campaign is almost over, which means Congress may soon be able to get back to business. One of the things it should prioritize is fixing a longstanding tax on innovation that most folks don’t know about, but they should:  the unfair legal treatment of Internet radio.

Internet radio is a favorite source of music for many, but there are relatively few big players in the medium. That’s because success in this space depends the ability to navigate through an obscure, rough-and-tumble neighborhood of copyright-land known as digital performance royalties. Thus far, that’s been a tough challenge: Internet radio services like Pandora pay about 50% of their revenues to record labels and artists, while satellite radio pays only about 10% and traditional AM/FM stations pay nothing.

Streaming digital music is one of very few types of creative work for which the price of a license isn't set in private by buyers and sellers. Instead, it's set by a panel of three judges in the Library of Congress called the Copyright Royalty Board, once every five years via a trial-like process. Music labels and musicians are represented by a company called SoundExchange, a spinoff of the RIAA. On the other side of the aisle are digital radio services like Pandora, satellite radio (Sirius XM), and cable radio companies like Muzak. As part of the process, parties present witnesses and evidence about the value of recorded music and the technology for delivering it to people's ears. The three judges then decide what royalties each kind of music service will have to pay for the next five years.

Music services aren't all treated the same, though - Congress gave older, more established companies a leg up. For satellite and cable radio, the judges set prices to give the labels and artists a "fair return" and the music service a "fair income."  In practice, the judges tell these services to pay about 10% of their revenues to the artists and labels. For Internet radio, though, the judges are supposed to set rates based on what a "willing buyer and a willing seller" would do in an open market.1 This sounds pretty good, except that there is no open market, so there’s no consistent benchmark. As a result, judges have set Internet radio royalty rates at cripplingly high levels. Internet stations went to Congress twice, in 2008 and 2009, to get temporary relief from rates that would have put them out of business. Today they pay about 50% of their revenues to SoundExchange.

Some of the same Congressmembers who helped lead the fight against the SOPA and PIPA bills this year want to level the playing field so that Internet radio can thrive. Congressmen Jason Chaffetz (R-Utah) and Jared Polis (D-Colorado), and Senator Ron Wyden (D-Oregon) introduced a bill called the Internet Radio Fairness Act, which will give Internet radio stations a fairer process for setting the price of their music - and probably much lower prices for that music.  

The legislation would put all digital music streaming companies on the same legal footing - Internet radio would get the same "fair return" standard that cable and satellite get, which will probably reduce the royalties Internet stations have to pay. The bill will also make sure that Internet radio stations can keep digital libraries of music to broadcast without facing copyright lawsuits. And it will help make sure that the Royalty Judges are qualified and can make decisions based on the best information.

As with all things copyright, the bill is polarizing. MusicFIRST, a coalition of record labels, artists' representatives, and unions, proposed another bill to standardize the digital radio rules - but their bill would apply the expensive "willing buyer/willing seller" standard to everyone. Other proposals would bring traditional AM/FM radio into the mix, requiring them to pay recording artists and labels for the music they play.

What's the right answer? It's tempting to say that the government shouldn't be setting the price of digital streaming any more than the price of milk, metal, or microchips. Downloadable music stores like iTunes and interactive streaming services like Spotify have to stand or fall in the free market. But Congress recognized that the market wasn't working for digital radio - negotiating licenses was too expensive and bargaining power was too out of balance to let these new technologies thrive, which is why it authorized the Royalty Board to step in. As long as the government is setting these rates, they should be using the best, fairest process possible. The Internet Radio Fairness Act will help make that happen.

11/2/2012 - This post was updated to reflect that MusicFIRST is a coalition of record labels, artists' representatives, and unions.

  • 1. These standards are in Sections 114 and 801 of the Copyright Act, which are as complex and opaque as the federal tax code.