E-Commerce Taxation & Regulation

With Bitcoin enjoying a spike in price against government currencies, there is lots of talk about it on the Interwebs, including Jerry’s typically thoughtful post from earlier today. If you’re not familiar with it yet, here’s a good Bitcoin primer, which also counsels reading a lot more before you acquire Bitcoin, as Bitcoin may fail. If you like Bitcoin and want to buy some, don’t go all goofy. Do your homework. As if you need to be told, be careful with your money.

Much of the commentary in the popular press declares a Bitcoin bubble for one reason or another. It might be a bubble, but nobody actually knows. A way of guessing is to compare Bitcoin’s qualities as a currency and payment network to the alternatives. Like any service or good, there are many dimensions to value storage and transfer.

I may not capture them all, and they certainly don’t predict the correct price against the dollar or other currencies. That depends on the ultimate viscosity of Bitcoin. But Bitcoin certainly has value of a different kind: it may discipline fiat currencies and the states that control them.

Intrinsic Value: If you’re just starting to think about money, this is where you’ll find Bitcoin an obvious failure. These evanescent strings of code have no intrinsic value whatsoever! Anyone relying on them as a store of value is a volunteer victim. Smart people stick with U.S. dollars and other major currencies, thin sheets of cloth or plastic with special printing on them…

No major currency has intrinsic value. Indeed, there isn’t much of anything that has intrinsic value. The value of a thing depends on other people’s demand for it. This is as true of Bitcoin as it is of dollars, sandwiches, and sand. So the intrinsic value question, which seems to cut in favor of traditional currencies, is actually a wash.

Transferability: Bitcoin is good with transferability–far better than any physical currency and quite a bit better than most payment systems. Not only is it fast, with transactions “settling” fairly quickly, but it is borderless. The genius of PayPal (after it gave up on being a replacement monetary system itself) was quick transfer to most places that rich people want to send money. Bitcoin allows quick transfer anywhere the Internet goes.

Acceptance: Bitcoin bombs badly in the area of acceptance. Try buying a sandwich with Bitcoin today and you’ll go hungry because few people and businesses accept it. This is a real problem, but it’s nothing intrinsic to Bitcoin. When Hank Aaron broke Babe Ruth’s home run record, people didn’t understand that credit cards were like money. (Watch the video at the link two or three times if you need to. It’s not only a great moment in sports.) Acceptance of different form-factors for value and payments can change.

Cost: How many billions of dollars per year do we pay for storage and transfer of money? Bitcoin is free.

Inflation-Resistance: Assuming the algorithms work as advertised, the quantity of Bitcoin will rise to a pre-established level of about 21 million over the next couple of decades and will never increase after that. This compares favorably to fiat currencies, the quantity of which are amended by their managers, sometimes quite dramatically, to undercut their value. If you want to hold money, holding Bitcoin is a better deal than holding dollars. Which brings us to…

Deflation-Resistance: Without central planners around to carefully debase its value, Bitcoin might go deflationary, with people refusing to spend it while it rises against all other stores of value and goods. Arguably, that’s what’s happening in the current Bitcoin price-spike. People are buying it in anticipation of its future increase in value.

Deflation can theoretically cause an economy to seize up, with everyone refusing to buy in anticipation of their money gaining in value over the short term. There is room for discussion about whether hyper-deflation can actually occur, how long a hyper-deflation can persist, and whether the avoidance of deflation is worth the risk of having centrally managed currency. I have a hard time being concerned that excessive savings could occur. However, whatever the case with those related issues, Bitcoin is probably deflation-prone compared to dollars and other managed currencies.

Surveillance-Resistance: Where you put your money is a reflection of your values. Payment systems and governments today are definitely gawking through that window into our souls.

Bitcoin, on the other hand, allows payments to be made with very little chance of their being tracked. I say “little chance” because there is some chance of tracking payments on the network. Sophisticated efforts to mask payments will be met by sophisticated efforts to track them. Relatively speaking, though, payments through traditional payment systems like checks, credit cards, and online transfer are super-easy to track. Cash is pretty darn hard to track. So Bitcoin stacks up well against our formal payment systems, but equally or perhaps poorly to cash.

Seizure-Resistance: The digital, distributed nature of Bitcoin makes it resistant to official seizure. Are you in a country that exercises capital controls? (What a euphemism, “capital controls.” It’s seizure.) Put your money into Bitcoin and you can email it to yourself. Carve your Bitcoin code into the inner lip of your frisbee before heading out on that Black Sea vacation. Chances are they won’t catch it at the border.

Traditional currencies either exist in physical form or they’re held and transferred by institutions that are more obediant to the state than they are loyal to their customers. (If Cyprus has anything to do with the current price-spike of Bitcoin, it’s as a lesson to others. Cypriots apparently did not move into Bitcoin in significant numbers.)

Because Bitcoin transactions are relatively hard to track, many can be conducted–how to put this?–independent of one’s tax obligations. In relation to the weight of the tax burden, Bitcoin may grow underground economies. Indeed, it flourishes where transactions (in drugs, for example) are outright illegal. Bitcoin probably moves the Laffer curve to the left.

Security: The tough one for Bitcoin is security. Most people don’t know how to store computer code reliably and how to prevent others from accessing it. Individuals have lost Bitcoin because of hard-drive crashes. (This will cause small losses in the total quantity of Bitcoin over time.) Bitcoin exchanges have collapsed because hackers broke in. And there’s a genuine risk that viruses might camp on your computer, waiting for you to open your (otherwise encrypted) wallet file. They’ll send your Bitcoin to heaven-knows-where the moment you do.

When a Bitcoin transaction has happened, it is final. Like a cash expenditure or loss, there is no reversability and nobody to complain to if you don’t have access to the person on the other side of the transaction. The downside of a currency that costs nothing to transfer is the lack of a 1-800 number to call.

So Bitcoin lags traditional currencies along the security dimension. But this is not intrinsic to Bitcoin. Security will get better as people learn and technology advances. (How ’bout a mega-firewall that requires approval of all outbound Internet traffic while the wallet is open?)

There may be Bitcoin-based payment services, banks, and lenders that provide reversibility, security, that pay interest, and all the other goodies associated with dollars today. To the extent they can stay clear of the regulatory morass, they may be less expensive, more innovative, and, in the early going, more risky.

So what’s the right price for Bitcoin? Only a fool can say. (No offense, all of you declaring a Bitcoin bubble.) I think it depends on the ultimate “viscosity” of Bitcoin.

Let’s say Bitcoin’s exclusive use becomes a momentary medium of exchange: Every buyer converts currency to Bitcoin for transfer, and every seller immediately converts it to her local currency. There’s not much need to hold Bitcoin, so there’s not that much demand for Bitcoin. Its equilibrium price ends up pretty low.

On the other hand, say everybody in the world keeps a little Bitcoin on hand for quick, costless transactions once there’s a handy, reliable, and secure Bitcoin payment system downloadable to our phones. If lots of people hold Bitcoin just because, that highly viscous environment suggests a high price for Bitcoin relative to other currencies and things.

Whatever the case, people are now buying Bitcoin because they think others are going to buy it in the future. Whether they’re “speculators” trying to buy in ahead of other speculators, or if they’re buying Bitcoin as a hedge against the varied weaknesses of fiat currencies and state-controlled payment systems, it doesn’t matter.

What does matter, I think, is having this outlet. The availability of Bitcoin is a small, but growing and important security against fiat currencies and state-controlled payments. It is a competitor to state money.

Bitcoin’s existence makes central bankers slightly less free to inflate the money they control, states will have slightly less success with seizing money, and surveillance of traditional payment systems will be decreasingly useful for law enforcement, taxation, and control.

I don’t think Bitcoin delivers us to libertarian “Shangri-la” or anarcho-capitalism, but it’s a technology that fetters government some. It’s a protection for people, their hard-earned wealth, and their privacy. That’s the value of Bitcoin, in my mind, no matter its current price.

I caught this tidbit today in a Washington Post article about Julius Genachowski’s tenure as Federal Communications Commission chairman:

He wound up presiding over a crucial period in which the powerful companies of Silicon Valley turned into Washington power players. Lobbying the FCC has become a major economic franchise. Each day, hundreds of dark-suited lawyers crowd the antiseptic, midcentury-modern agency building.

Can anyone think this is a good thing? To be clear, I don’t think Genachowski is solely responsible for Silicon Valley innovators getting more aggressive in Washington or for tech lobbying becoming “a major economic franchise” at the FCC. There’s plenty of blame to go around in that regard. Regardless, every legislative and regulatory action that opens the door to greater regulation of the information economy also opens the door a bit wider to unproductive rent-seeking and cronyist activities. Moreover, every minute and every dollar spent focusing on making legislators and regulators happy is another minute and dollar that could have better been spent making consumers happy in the marketplace. It’s a pure deadweight loss to society.

And there has been a remarkable expansion in such tech lobbying activity over the past decade, as the following charts illustrate. The first shows the dramatic growth of lobbying by computer and Internet companies relative to other sectors and the second shows lobbying spending by specific computer and Internet companies. [Click to enlarge.]

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With each passing year, Washington’s appetite for Internet regulation grows. While “Hands Off the Net!” was a popular rallying cry just a decade ago—and was even a shared sentiment among many policymakers—today’s zeitgeist seems to instead be “Hands All Over the Net.” Countless interests and regulatory advocates have pet Internet policy issues they want Washington to address, including copyright, privacy, cybersecurity, online taxation, broadband regulation, among many others.

Rep. Darrell Issa (R-CA) wants to do something to slow down this legislative locomotive. He has proposed the “Internet American Moratorium Act (IAMA), which would impose a two-year moratorium on “any new laws, rules or regulations governing the Internet.” The prohibition would apply to both Congress and the Executive Branch but makes an exception to any rules dealing with national security.

Will Rep. Issa’s proposal make any difference if implemented? Any congressionally imposed legislative moratorium is a symbolic gesture and not a binding constraint since Congress is always free to pass another law later to get around an earlier prohibition. So, in that sense, a moratorium might not change much. Nonetheless, such symbolic gestures are often important and Issa is to be commended for at least trying to raise awareness about the dangers of creeping regulation of online life and the digital economy.

If policymakers really want to take a more substantive step to slow the flow of red tape, they should consider a different approach. Instead of (or, perhaps, in addition to) a two-year legislative moratorium, they should impose a variant of “Moore’s Law” for information technology laws and regulations. “Moore’s Law,” as most of you know, is the principle named after Intel co-founder Gordon E. Moore who first observed that, generally speaking, the processing power of computers doubles roughly every 18 months while prices remain fairly constant.

As I argued in a Forbes column earlier this year, we should apply this same principle to high-tech policy. Continue reading →

Post image for Dan Provost on indie capitalism

Designer Dan Provost, co-founder of the indie hardware and software company Studio Neat, and co-author of It Will Be Exhilarating: Indie Capitalism and Design Entrepreneurship in the 21st Century, discusses how technological innovation helped him build his business. Provost explains how he and his co-founder Tom Gerhardt were able to rely on crowdfunding to finance their business. Avoiding loans or investors, he says, has allowed them to more freely experiment and innovate. Provost also credits 3D printing for his company’s success, saying their hardware designs–very popular tripod mounts for the iPhone and a stylus for the iPad–would not have been possible without the quick-prototyping technology.

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Steve Titch gave you a thorough run-down last week. Now Tim Carney has a quick primer on the push by big retailers to increase tax collection on goods sold online.

S. 1832, the Marketplace Fairness Act currently enjoys no affirmative votes on WashingtonWatch.com. Good.

The U.S. Senate holds hearings Wednesday on the so-called Market Fairness Act (S. 1832), which would be better dubbed the “Consumer and Enterprise Unfairness Act,” as it seeks to undo a critical requirement that prevents states from engaging in interstate tax plunder.

In a series of court decisions that stretch back to the 1950s, the courts have consistently affirmed that a business must have a physical presence within a state in order to be compelled to collect sales taxes set by that state and any local jurisdiction.

That meant catalogue and mail order businesses were not required to collect sales tax from customers in any other state but their own. The three major decision that serve as the legal foundation for this rule, including Quill v. North Dakota, the case cited most frequently.

Quill left room for Congress to act, which indeed it is doing with the Market Fairness Act. The impetus for the act has nothing to with the catalogue business, however. Rather, it’s the  estimated $200 billion in annual Internet retail sales, a significant portion of which escapes taxation, that’s got the states pushing Congress to take a sledgehammer to a fundamental U.S. tax principle that has served the purpose of interstate commerce since 1787.

That year, of course, is when the U.S. Constitution replaced the Articles of Confederation. One of the flaws of the Articles was that it permitted each of the states to tax residents of others. Rather than get the budding nation closer to the nominal goal of confederation, it was endangering the expansion of vital post-colonial commerce by creating 13 tax fiefdoms and protectorates. The authors of the Constitution wisely addressed this by vesting the regulation of interstate commerce in the federal government.

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Proponents of higher taxes have taken to calling the exemption that out-of-state online shoppers enjoy a “loophole,” as if it were an unintended flaw in two established court rulings that addressed the power of one state to tax residents of another.

My latest commentary at Reason.org looks at the so-called Marketplace Fairness Act, a bill that the House Judiciary Committee has scheduled for hearings tomorrow. The bill aims to help states collect sales taxes on out-of-state purchases, typically made via catalogue or, to an ever-greater extent, the Internet. Two Supreme Court decisions, Quill vs. North Dakota and National Bellas Hess vs. [Illinois] Department of Revenue, both of which pre-date Internet shopping, protect out-of-state consumers from the taxman’s reach.

As I write:

Editorials and op-eds supporting the bill, such as in the Arizone Daily Star and the Chicago Sun-Times, say it will close a “loophole” that allows Internet purchases to escape taxation. This is akin to saying the Supreme Court’s Miranda decision is a loophole for defendants to escape prosecution. No doubt some overzealous prosecutors may think so, but in truth, Miranda sharpened and affirmed the right of due process already present in the Fourth and Fifth Amendments. Likewise, in Quill and Bellas Haas, the courts sharpened and affirmed the Constitution’s commerce clause that prevents one state from taxing residents of another.

Seeing it as counterproductive to an interdependent economy, the Founders did not want states plundering each other’s residents and enterprises with taxes. Yet that’s exactly the environment the Marketplace Fairness Act sets up. New York State can tax residents of Illinois and the Prairie State can tax Hoosiers.

In doing so, the Marketplace Fairness Act ignores the constitutional underpinnings of the Quill and Bellas Hess decisions and treats the Internet sales tax issue as a procedural issue when the in fact the constitutional bar is set much higher. The giveaway, however, is the portion of the bill that requires states to simplify their state tax collection procedures before launching cross-border taxation. It’s an unusual quid pro quo, perhaps because Congress has to offer states the prerequisite of a buy-in. That’s because any attempt to impose a tax collection structure wholesale on the states would likely face a constitutional challenge on 10th Amendment grounds of state’s rights.

In reality, the states, struggling as they are with debt crises of their own making, are angling for a greater piece of the $200 billion Americans are spending with Internet merchants each year. Of course, not all of this goes untaxed; on-line retailers who have brick-and-mortar stores within a state must collect tax from residents in that state. Besides creating a mess of competing state tax grabs, this law stands to increase paperwork and complexity for thousands of small online businesses and catalogue firms, who would now be obliged to calculate taxes on some 11,000 sales tax jurisdictions throughout the country. Whether or not it’s “simplified” in line with some Congressional definition, it still stands to be the burden as noted in Quill and Bellas Hess.

But all the talk of loopholes, level playing fields and what does or does not constitute a “burden” diverts attention from the real issue. The Marketplace Fairness Act is not about the Internet, e-commerce, the marketplace or fairness–it’s about what the Constitution says about the power of state governments to tax citizens beyond their borders.

The Reason Foundation today has published the Telecommunications and Internet section of its 2011 Annual Privatization Review.

Although there’s been a bit of lead time since the articles were written, they are still timely. Notable is the discussion on the collection of state sales taxes from Internet retailers, back in the news now that Amazon.com has reached an agreement with the state of Texas to collect sales taxes from consumers in the Lone Star State. The settlement concludes a lengthy battle in Austin as to whether Amazon’s distribution facility in Ft. Worth constitutes a “nexus” as defined in previous court cases.

While a blow to Amazon’s Texas customers (full disclosure: I count myself as one), the action may shed further light on the debate as to how much advantage the Amazon has because it can waive sales tax collection. Competitors such as ailing Best Buy have said it’s enough to hurt brick-and-mortar retailers. Amazon points to findings that in New York, the most populous state where it collects sales tax, sales have not fallen off. Soon we’ll see if Texas tracks with that data as well. If it does, it will further validate opinions that Amazon and other on-line retailers are succeeding because they have fundamentally changed the way people shop, not because they can simply avoid sales taxes.

Also in the report look for updates on the FCC’s options for the next spectrum auction, state and federal policymaking on search engines and social networking sites, and how priorities may change as the FCC migrates from the current Federal Universal Service Fund to its new more broadband-oriented Connect America Fund.

The telecom section of APR 2011 can be found here.

A few weeks back, now-former Best Buy CEO Brian Dunn blamed the retailer’s $1.7 billion quarterly loss and its decision to close 50 stores nationwide on the fact that its online competitors, Amazon.com in particular, “aren’t encumbered by the costs of running physical locations and in many cases don’t have to collect sales tax.”

Dunn’s comments rehash the now-familiar meme that forcing e-retailers to collect sales tax is the silver bullet to saving brick-and-mortar retailers. It gives politicians on all sides cover–for some, it’s a way to keep revenues coming in for excessive spending. For others, it’s a handy way to wave the flag for local commerce.

But slapping consumers with more taxes isn’t going to save retailing. In a short piece this week, BusinessWeek explores the fundamental shifts online retailing has created in consumer behavior. Here’s a nugget from the article:

Best Buy’s decline reflects a cultural shift that’s reshaping the retail world. All big-box stores, and Best Buy in particular, thrived in an era when comparison shopping meant physically going from store to store. The effort required of consumers was a kind of transactional friction. With the advent of mobile technology, friction has all but disappeared. Rather than ruminate with a salesperson before making a selection, tech-savvy consumers are more likely to walk into stores, eyeball products, scan barcodes with their smartphones, note cheaper prices online, and head for the exit. Shoppers can purchase virtually any product under the sun on Amazon or eBay while sipping a latte at Starbucks. For traditional retailers, that spells trouble, if not death. “So far nothing Best Buy is doing is fast enough or significant enough to get in front of these waves,” says Scot Wingo, CEO of e-commerce consulting firm ChannelAdvisor.

Certainly e-commerce created competitive problems for Best Buy, but the sales tax advantage was likely the least of them. Brick-and-mortar retailing is facing an out-and-out crisis that’s going to require creativity and innovation to solve. Taxing consumers who buy online won’t do much toward that end.

And for more, see Adam’s post on Heritage Foundation’s new report on Internet tax policy.

Heritage Foundation released a new study this week arguing that “Congress Should Not Authorize States to Expand Collection of Taxes on Internet and Mail Order Sales.” It’s a good contribution to the ongoing debate over Internet tax policy. In the paper, David S. Addington, the Vice President for Domestic and Economic Policy at Heritage, takes a close look at the constitutional considerations in play in this debate. Specifically, he examines the wisdom of S. 1832, “The Marketplace Fairness Act.” Addington argues that, “enactment of S. 1832 would discourage free market competition” and raise a host of other issues:

The Constitution of the United States has set the legal baseline—the level playing field—around which the American free-market economy has built itself. The Constitution, as reflected in the Quill decision, is the source of the present arrangement regarding collection of state sales and use taxes by remote sellers. Ever since the Supreme Court decided Quill in 1992, American businesses have made millions of business decisions in the competitive marketplace based in part on settled expectations regarding state taxation affecting their sales transactions. The states and businesses advocating S. 1832 seek to change the current, constitutionally prescribed playing field. They seek to use governmental power to intervene in the economy to help in-state, store-based businesses by imposing a new tax-collection burden on out-of-state competitors who sell over the Internet, through mail order catalogs, or by telephone. Free-market principles generally discourage such government intervention in the economy to pick winners and losers based on legislative policy preferences.

Veronique de Rugy and I raised similar concerns in both a recent Mercatus white paper (“The Internet, Sales Taxes, and Tax Competition“) and an earlier 2003 Cato white paper, (“The Internet Tax Solution: Tax Competition, Not Tax Collusion”). We argued that there are better ways to achieve “tax fairness” without sacrificing tax competition or opening the doors to unjust, unconstitutional, and burdensome state-based taxation of interstate sales. Specifically, we point out that an “origin-based” sourcing rule would be the cleanest, most pro-constitutional, and pro-competitive alternative. I also discussed these issues at a recent Cato event. [Video follows.]