Message: 58
Date: 05.1.98
From: <nicholas@media.mit.edu>
To: <lr@wired.com>

Taxing Taxes

After discovering the basic principle of electromagnetic induction in 1831, Michael Faraday was asked by a skeptical politician what good might come of electricity. "Sir, I do not know what it is good for," Faraday replied. "But of one thing I am quite certain - someday you will tax it." Little did he know how right he was, though more than a century would pass before the word bits existed.

The idea of taking a tax bite out of digital communications comes courtesy The Club of Rome, specifically Arthur Cordell and Ran Ide's 1994 report "The New Wealth of Nations." More recently, redistributing the benefits of the information society has been championed by influential economist Luc Soete, director of the Maastricht Economic Research Institute on Innovation and Technology. Despite their repute, supporters of such a bit tax are clearly clueless about the workings of the digital world.

Tax bytes
A typical book contains about 10 million bits, which might take even a fast reader several hours to digest. By contrast, typical video - digital and compressed - burns through 10 million bits to produce less than four seconds of enjoyment. A bit consumption tax, in other words, makes no more sense than tariffing toys by the number of atoms. Maybe the information highway metaphors have gone to the heads of digitally homeless economists, who think they can assess value by something akin to counting cars.

Of course, collecting taxes can be tough enough without trying to assess something you can't see, especially when you don't know where it is going to or coming from. This helps explain why the Clinton administration in late February reaffirmed its commitment to making cyberspace a global free-trade zone. The policy's purpose, the brainchild of White House senior adviser Ira Magaziner, is both economic stimulus and practicable fairness. So whether or not Congress has kept its promise to vote on the related Internet Tax Freedom Act by early spring, the legislation has the full force of careful deliberation - and historical inevitability - behind it. For these and other reasons, Europe abandoned the bit tax. But the idea still survived three and a half years of consideration, despite the growing awareness that bits by their very nature defy taxation.

The locus pocus of sales tax
Even so, the principled position taken by Clinton and Congress comes, in part, because making the Net a free-trade zone works for the US federal government. The Treasury derives most of its revenues from personal and corporate income taxes. If the economy sees a boost from any form of free trade, the Feds will see a proportionate rise in their own intake. Simple arithmetic.

However, many countries and most states don't work that way. Instead, a sales tax is the means - often the principal means - of filling government coffers. Ohio governor George Voinovich, chair of the National Governors' Association, declared that the Internet Tax Freedom Act "represents the most significant challenge to state sovereignty that we've witnessed over the last 10 years." Both he and the act may be right.

The sales tax is also particularly popular among bureaucrats in developing nations, where collecting income tax is even harder because the poor make so little and the rich can avoid so much. Plus, the sales tax turns retailers into a nationwide web of tax collectors. And the tax is "fair" because it's based on what you spend versus what you earn.

Still, Voinovich and company would be smart to start looking elsewhere, because their receipts will plummet as we buy more and more online, especially if what we buy are bits.

The VAT vat
While the sales tax is fairly commonplace, the value-added tax is more or less unknown in the United States. Loosely speaking, it taxes the various stages of transforming raw material into a finished product, the last stage of value added being what you pay at the retail counter (and get back at the airport's VAT-refund counter).

This kind of tax makes even less sense in the world of bits.

Assume that bits are my stock in trade and I use Microsoft Word to refine my raw material: Should I pay a VAT for spellchecking each story? Should I pay a VAT to have it encrypted and another to have it decrypted, not to mention on each of the layers of value added by various editors? In fact, as a cheerful taxpayer, if I have to pay taxes on bits - at least those that make up words - I would be willing to pay a higher VAT for the fewest possible bits: just the right ones, please. That would be value added indeed.

Jurisdiction in jeopardy
But the most taxing aspect of cyberspace is not the ephemeral nature of bits, the marginal cost of zero to make more of them, or that there is no need for warehouses to store them. It is our inability to say accurately where they are. If my server is in the British West Indies, are those the laws that apply to, say, my banking? The EU has implied that the answer is yes, while the US remains silent on the matter.

What happens if I log in from San Antonio, sell some of my bits to a person in France, and accept digital cash from Germany, which I deposit in Japan? Today, the government of Texas believes I should be paying state taxes, as the transaction would take place (at the start) over wires crossing its jurisdiction. Yikes. As we see, the mind-set of taxes is rooted in concepts like atoms and place. With both of those more or less missing, the basics of taxation will have to change. Taxes in the digital world do not neatly follow the analog laws of physics, which so conveniently require real energy, to move real things, over real borders, taxable at each stage along the way. Of course, even analog taxation without representation is no tea party.

Getting physical
Looking ahead, taxes will eventually become a voluntary process, with the possible exception of real estate - the one physical thing that does not move easily and has computable value. The US has a jump-start on the practice, in that 65 percent of local school funds come from real estate taxes - a practice Europeans consider odd and ill advised. But wait until that's all there is left to tax, when the rest of the things we buy and sell come from everywhere, anywhere, and nowhere.

Next: Bandwidth Revisited

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[Copyright 1998, WIRED Ventures Ltd. All Rights Reserved. Issue 6.05, May 1998.]