by Walter Stover and Anne Hobson

Franklin Foer’s article in the Atlantic on Jeff Bezos’s master plan offers insight into the mind of the famed CEO, but his argument that Amazon is all-powerful is flawed. Foer overlooks the role of consumers in shaping Amazon’s narrative. In doing so, he overestimates the actual autonomy of Bezos and the power of Amazon over its consumers. 

The article falls prey to an atomistic theory of Amazon. The thinking goes like this: I am an atom, and Amazon is a (much) larger atom. Because Amazon is so much larger than I am, I need some intervening force to ensure that Amazon does not prey on me. This intervening force must belong to an even larger atom (the U.S. government) in order to check Amazon’s power. The atomistic lens sees individuals as interchangeable and isolated from each other, able to be considered one at a time.

Foer’s application of this theory appears in his treatment of Hayek, one of the staunchest opponents of aggregation and atomism. For example, when he summarizes Hayek’s paper “The Use of Knowledge in Society,” he phrases Hayek’s argument as that “…no bureaucracy could ever match the miracle of markets, which spontaneously and efficiently aggregate the knowledge of a society.” Hayek found the notion of aggregation highly problematic, as seen in another of his articles, “Competition as a Discovery Procedure,” in which he criticizes the idea of a “scientific” objective approach to measuring market variables. His argument against trying to build a science on macroeconomic variables notes that “…the coarse structure of the economy can exhibit no regularities that are not the results of the fine structure… and that those aggregate or mean values… give us no information about what takes place in the fine structure.”

Neither Amazon nor the market can aggregate the knowledge of a society. We can try to speak of the market in aggregate terms, but we end up summing up all of the differences between individuals and concealing the action and agency of the individuals at the bottom. We cannot speak of market activity without reference to the patterns of individual interactions. It is best to think of the market as an emergent, unintended outcome of a constellation of individual actors, not atoms, each of whom have different talents, wants, knowledge, and resources. Actors enter into exchanges with each other and form complicated, semi-rigid, multi-leveled social networks.

Foer describes the great power and wealth of “knowledge” that Amazon has acquired:

“Amazon, however, has acquired the God’s-eye view of the economy that Hayek never imagined any single entity could hope to achieve. At any moment, its website has more than 600 million items for sale and more than 3 million vendors selling them. With its history of past purchases, it has collected the world’s most comprehensive catalog of consumer desire, which allows it to anticipate both individual and collective needs. With its logistics business—and its growing network of trucks and planes—it has an understanding of the flow of goods around the world. In other words, if Marxist revolutionaries ever seized power in the United States, they could nationalize Amazon and call it a day.”

“…[Amazon] distributes economists across a range of teams, where they can, among other things, run controlled experiments that permit scientific, and therefore effective, manipulation of consumer behavior.”

Yet, having data (or having PhD economists, for that matter) is not the same as having complete knowledge or predictive power. Again, the atomistic theory reappears in the assumption that the behavior of individuals can be predicted based on past information in the same way we could compute the trajectory of a single billiard ball. The local, dispersed knowledge Hayek discussed in “The Use of Knowledge” is subjectively held in the minds of the actors, and thus inaccessible to outside observers. People do not, in fact, carry around independently fixed utility functions in their heads from which they–or anyone else–can accurately predict what they will choose in the future. 

 Instead, as economist James Buchanan argues, choices are genuine in that “participants do not know until they enter the process what their own choices will be.” In other words, wants are themselves generated in the choosing process. Amazon cannot reverse engineer the process from any single snapshot, or any series of snapshots, because choices are subjective and dynamic. As an example, any behavior–such as targeted ads or preferential pricing–based on attempts to predict future patterns of consumer behavior is itself information that enters into consumer purchasing decisions. 

Even assuming that Amazon could perfectly predict consumer preferences, this would not pose any kind of threat to consumer welfare, because consumers still retain the ability to shop elsewhere. And competition on the retailer front is still rampant. Walmart has 265 million customers each week and 2.2 million global employees. By contrast, Amazon has 105 million prime subscribers and 613,300 global employees. As long as Amazon cannot exercise coercive authority over consumers, it remains unclear why, exactly, increased predictive power would damage consumer welfare. 

When discussing the high level of trust consumers have in Amazon, Foer argues that “…while Amazon is trusted, no countervailing force has the inclination or capacity to restrain it.” 

Foer again ignores the diffuse countervailing power of consumers, somewhat similar in fashion to Hayek’s notion of dispersed knowledge. Individuals may not be able to exercise much power by themselves against Amazon, but they wield extraordinary power when taking the entire constellation of actors into consideration. This is not the same thing as a collective, organized response such as unions or consumer welfare protection organizations such as the Better Business Bureaus, though these organizations doubtless have very important roles to play. 

In the same way that the market order is a spontaneous outcome of individuals pursuing their own interests, the decentralized actions of consumers in the market similarly can result in the fortunes or fall of a firm without the need to organize everyone involved. Every choice made in the market on the margin is a signal to the firm. A decision to buy books from other websites (for example, from Alibris and not Amazon) is a minute manifestation of this diffuse power of consumers. One signal by itself does not carry much leverage, but when taken in totality, they constitute an ordered force that exerts powerful feedback on a firm’s actions. 

Such a theory of diffuse power can appear profoundly unsatisfactory. We tend to favor narratives of Davids versus Goliaths in part perhaps because we are unaccustomed to trying to think about spontaneous orders in general. In the long run, Amazon will live or die, but not according to the schedule or preferences of a single consumer. 

Diffuse power might seem to be a weak check, but what is the alternative? There are risks to policy intervention (as Foer points out, Marxists could nationalize Amazon and then try to use the consolidated information to run the economy, with disastrous results). Policymakers could restrict Amazon’s growth or activity in a way that limits innovation. It could step in too early and prevent consumer signals from running their course and changing Amazon’s direction to align more with our wants. 

Consumer signals in totality do serve as a countervailing force. And the evidence is in Foer’s article. Amazon (and Bezos in particular) is obsessed with consumer satisfaction and we all benefit from his obsession.

Note: This piece is part three of a series on the epistemic limitations of Artificial Intelligence. Part one on “The Limits of AI in Predicting Human Action” of that series can be found here. Part two on “Amazon, Artificial Intelligence, and Digital Market Manipulation” can be found here.

Yesterday, the Supreme Court dropped a decision in Wayfair v. South Dakota, a case on the issue of online sales tax. As always, the holding is key: “Because the physical presence rule of Quill is unsound and incorrect, Quill Corp. v. North Dakota, 504 U. S. 298, and National Bellas Hess, Inc. v. Department of Revenue of Ill., 386 U. S. 753, are overruled.” What follows below is a roundup of reactions and comments to the decision.

Joseph Bishop-Henchman at the Tax Foundation thinks this decision sets up a new political fight in Congress and in the states:

All eyes will now turn to Congress and the states. Congress has been stymied between alternate versions of federal solutions: the Remote Transactions Parity Act (RTPA) or Marketplace Fairness Act (MFA), which lets states collect if they agree to simplify their sales taxes, and a proposal from retiring Rep. Bob Goodlatte (R-VA) that would make the sales tax a business obligation rather than a consumer obligation, and have it collected based on the tax rate where the company is located but send the revenue to the jurisdiction where the customer is located. RTPA and MFA are more workable and more likely to pass, but Goodlatte controls what makes it to the House floor, so nothing has happened. Maybe today’s decision will change that.

Berin Szoka at TechFreedom noted:

For the last twenty-six years, the Internet has flourished because of the legal certainty created by Quill. Now, no retailer can know whether it must collect taxes, and smaller retailers face huge challenges. As Chief Justice Roberts notes, the majority ‘breezily disregards the costs that its decision will impose on retailers.’ The majority insists that software will fix the problem of calculating the correct state and local sales tax for every transaction, but with over 10,000 jurisdictions taxing similar products differently, the problem is nightmarishly complicated.

My colleague Doug Holtz-Eakin explains the tension:

What is the economic upshot of this decision? Certainly, it puts in-state and brick-and-mortar retailers on a level playing field with online sellers. In isolation, that is an improvement in the efficiency of the economy because people will shop based on the product and experience and not the tax consequences. Recall, however, that in many states a resident is liable for the “use tax” on her out-of-state purchases. If the sales tax is now being collected, it will be important for states either to drop the use tax or to make sure that there is no double taxation in some other way. If not, then the result of this decision will be less efficiency.

Another aspect of the decision is the impact on federalism and the notion of representation. The decision means that South Dakota can now dictate some of the business operations of firms that have no representation in the South Dakota legislature. Is that fair? Moreover, firms can no longer shop among states to find the sales tax regime that they like best — they will be subject to the same sales taxes across the country regardless of where they operate.

Grover Norquist at American for Tax Reform had this to say:

Today the Supreme Court said ‘yes—you can be taxed by politicians you do not elect and who act knowing you are powerless to object.’ This power can now be used to export sales taxes, personal and corporate income taxes, and opens the door for the European Union to export its tax burden onto American businesses—as they have been demanding…

We fought the American Revolution in large part to oppose the very idea of taxation without representation. Today, the Supreme Court announced, ‘oops’ governments can now tax those outside their borders—those who have no political power, no vote, no voice.

Adam Michel of the Heritage Foundation also focused on federalism at The Daily Signal:

The new status quo under Wayfair is untenable, creating a Wild West for state sales taxes. Some will point to seemingly easy solutions that have been promoted for decades. One example is the Remote Transactions Parity Act, sponsored by Rep. Kristi Noem, R-S.D.

Noem’s bill would maintain the new expanded power of state tax collectors, while imposing nominal limits and simplifications on states’ tax rules.

Such proposals that force sellers to track their sales to the consumer’s destination and comply with laws in other jurisdictions are fundamentally at odds with the principles of local government and American federalism.

Rob Port is concerned about the interstate commerce implications:

The purpose of the interstate commerce clause is to prevent the nightmare of fifty states squabbling with one another over trade wars between their constituent industries, or trying to exert political influence on one another. Congress, and not the states, is to regulate interstate commerce.

I feel like the Supreme Court, by overturning Quill and giving the states new powers to tax beyond their borders, has weakened interstate commerce protections and cracked open the lid to a real can of worms.

All Things SCOTUS has a list of reactions from conservatives.

[originally published on Plaintext on June 21, 2017.]

This summer, we celebrate the 20th anniversary of two developments that gave us the modern Internet as we know it. One was a court case that guaranteed online speech would flow freely, without government prior restraints or censorship threats. The other was an official White House framework for digital markets that ensured the free movement of goods and services online.

The result of these two vital policy decisions was an unprecedented explosion of speech freedoms and commercial opportunities that we continue to enjoy the benefits of twenty years later.

While it is easy to take all this for granted today, it is worth remembering that, in the long arc of human history, no technology or medium has more rapidly expanded the range of human liberties — both speech and commercial liberties — than the Internet and digital technologies. But things could have turned out much differently if not for the crucially important policy choices the United States made for the Internet two decades ago.

First, on June 26, 1997, the Supreme Court handed down its landmark decision in Reno v. ACLU, which struck down the Communications Decency Act’s provisions seeking to regulate online content under the old broadcast media standard. The Court concluded that there was “no basis for qualifying the level of First Amendment scrutiny that should be applied to this medium” and rejected the congressional effort to pigeonhole this exciting new medium into the archaic censorship regimes of the past.

The Reno decision was tremendously important in protecting online speakers from the chilling effect of government “indecency” regulations. The decision also set a strong legal precedent and was cited in countless subsequent decisions involving not only online speech, but also efforts to regulate video game content.

Second, in July 1997, the Clinton Administration released The Framework for Global Electronic Commerce, a document that outlined the US government’s new policy approach toward the Internet and the emerging digital economy. The Framework was a bold vision statement that endorsed comprehensive online freedom of exchange, saying that “the private sector should lead [and] the Internet should develop as a market driven arena not a regulated industry.” The Administration rejected a restrictive regulatory regime for commercial activities and instead recommended reliance on civil society, contractual negotiations, voluntary agreements, and industry self-regulation.

To “avoid undue restrictions on electronic commerce,” the vision statement recommended that “parties should be able to enter into legitimate agreements to buy and sell products and services across the Internet with minimal government involvement or intervention.” But, “[w]here governmental involvement is needed, its aim should be to support and enforce a predictable, minimalist, consistent and simple legal environment for commerce.”

Taken together, the Reno decision and the Clinton Administration’s Framework acted as a Magna Carta moment for the Internet and digital technologies. It signaled that “permissionless innovation” would become America’s governance stance toward online speech and commerce.

As I defined it in a book on the subject, permissionless innovation, “refers to the notion that experimentation with new technologies and business models should generally be permitted by default. Unless a compelling case can be made that a new invention will bring serious harm to society, innovation should be allowed to continue unabated and problems, if any develop, can be addressed later.” The primary advantage of permissionless innovation as a governance disposition is that it sends a clear green light to citizens telling them they are at liberty to pursue their own interests and passions, free from the suffocating grip of prior restraints on free speech and free exchange.

But the Reno decision and the Clinton Administration’s Framework are not the only critical policy decisions that helped enshrine permissionless innovation as the lodestar of online policy in the US. In the mid-1990s, the Clinton Administration made the decision to allow open commercialization of the Internet, which was previously just the domain of government agencies and university researchers. Even more crucially, when Congress passed and President Bill Clinton signed into law the Telecommunications Act of 1996, lawmakers made it clear that traditional analog-era communications and media regulatory regimes would generally not be applied to the Internet.

The Telecom Act also included an obscure provision known as “Section 230,” which immunized online intermediaries from onerous liability for the content and communications that traveled over their networks. Section 230 was hugely important in that it let online speech and commerce flourish without the constant threat of frivolous lawsuits looming overhead. Internet scholar David Post has argued that “it is impossible to imagine what the Internet ecosystem would look like today without [Section 230]. Virtually every successful online venture that emerged after 1996 — including all the usual suspects, viz. Google, Facebook, Tumblr, Twitter, Reddit, Craigslist, YouTube, Instagram, eBay, Amazon — relies in large part (or entirely) on content provided by their users, who number in the hundreds of millions, or billions,” he notes. It is unlikely that the vibrant marketplace of online speech and commerce we enjoy today could have existed without the protections afforded by Section 230.

Finally, in 1998, another important legislative development occurred when Congress passed the Internet Tax Freedom Act, which blocked all levels of government in the US from imposing discriminatory taxes on the Internet. That made it clear that the Net would not be milked as a “cash cow” the way previous communications systems had been.

So, let’s recap how policymakers generally got policy right for the Internet in the mid-1990s by enshrining permissionless innovation as the law of the land:

• The Executive Branch set the tone for online freedom by fully privatizing the underlying network and then establishing a governance vision based upon minimal government interference with online speech and exchange.
• The Legislative Branch generally endorsed the Clinton Administration’s vision for the Internet and digital technologies by ensuring that new policies would not be based upon the failed regulatory and tax policies of the past.
• The Judicial Branch upheld the centrality of the First Amendment in the Information Age and made it clear that this new medium for speech would be granted the strongest protection against government encroachments on freedom of speech and expression.

The combined effect of these wise, bipartisan policy decisions was that the Net and digital tech were “born free” instead of being born into regulatory captivity. We continue to enjoy the fruits of these freedoms today as citizens here in the US and across the world take advantage of the unprecedented ability to connect and communicate to pursue their passions and interests as they see fit.

There’s still more work to be done, however. Online platforms and digital technologies continue to come under attack from regulatory activists both here and abroad. Many governments continue to push back against these online speech and commercial freedoms, meaning we’ll need to redouble our efforts to highlight and defend the benefits of preserving these important victories.

Finally, as the underlying drivers of the Digital Revolution continue to spread into other segments of the economy, these freedoms will come into conflict with older top-down regulatory regimes for automobiles, aviation, medical technology, finance, and much more. This will create an epic conflict of governance visions between the Internet’s permissionless innovation model versus the precautionary, command-and-control regulatory regimes of the industrial age. We already see tension at work in policy deliberations over the Internet of Things, “big data,” driverless cars, commercial drones, robotics, artificial intelligence, 3D printing, virtual reality, the sharing economy, and others.

If policymakers hope to preserve and extend the benefits of the hard-fought victories of the Internet’s past twenty years, they will need to restate and reinvigorate their commitment to permissionless innovation to help spur the next great technological revolutions in these and other fields.

This article originally appeared at techfreedom.org.

Today, TechFreedom joined a coalition of over 40 organizations from across the country in urging Senate leadership to permanently ban taxes on Internet access. In a letter to Majority Leader Mitch McConnell and Minority Leader Harry Reid, the coalition voiced support for a permanent extension of the Internet Tax Freedom Act (ITFA), which bans states and localities from imposing Internet access taxes and discriminatory taxes on electronic commerce. The bill is currently embedded in H.R. 644, the Trade Facilitation and Enforcement Act.

The letter reads:

After decades of progress in connecting more Americans to the Internet, the lack of a permanent ban on Internet access taxes could reverse this progress. Numerous studies continue to show that cost remains an obstacle to Internet access and, if taxes on the Internet go up, even fewer people will be able to afford to go online. This would impede our nation’s long held goal of universal Internet access.

“ Americans’ broadband bills shouldn’t be used as bargaining chips by Senators who want to impose online sales taxes,” said Tom Struble, Policy Counsel at TechFreedom. “For 17 years, the Internet access tax ban has helped encourage broadband adoption and investment. If Senators want an online sales tax, then pass it on the merits — but handcuffing a broadband tax with sales tax is irresponsible. Consumers are already facing the prospect of higher bills, as the FCC is likely to soon impose universal service fees on broadband as part of its Title II regime imposed in the name of ‘net neutrality.’ Let’s not make that problem worse. The Senate should act quickly to end the uncertainty and pass permanent, Internet tax freedom.”

The Federal Trade Commission (FTC) is taking a more active interest in state and local barriers to entry and innovation that could threaten the continued growth of the digital economy in general and the sharing economy in particular. The agency recently announced it would be hosting a June 9th workshop “to examine competition, consumer protection, and economic issues raised by the proliferation of online and mobile peer-to peer business platforms in certain sectors of the [sharing] economy.” Filings are due to the agency in this matter by May 26th. (Along with my Mercatus Center colleagues, I will be submitting comments and also releasing a big paper on reputational feedback mechanisms that same week. We have already released this paper on the general topic.)

Relatedly, just yesterday, the FTC sent a letter to Michigan policymakers about restricting entry by Tesla and other direct-to-consumer sellers of vehicles. Michigan passed a law in October 2014 prohibiting such direct sales. The FTC’s strongly-worded letter decries the state’s law as “protectionism for independent franchised dealers” noting that “current provisions operate as a special protection for dealers—a protection that is likely harming both competition and consumers.” The agency argues that:

consumers are the ones best situated to choose for themselves both the vehicles they want to buy and how they want to buy them. Automobile manufacturers have an economic incentive to respond to consumer preferences by choosing the most effective distribution method for their vehicle brands. Absent supportable public policy considerations, the law should permit automobile manufacturers to choose their distribution method to be responsive to the desires of motor vehicle buyers.

The agency cites the “well-developed body of research on these issues strongly suggests that government restrictions on distribution are rarely desirable for consumers” and the staff letter continues on to utterly demolish the bogus arguments set forth by defenders of the blatantly self-serving, cronyist law. (For more discussion of just how anti-competitive and anti-consumer these laws are in practice, see this January 2015 Mercatus Center study, “State Franchise Law Carjacks Auto Buyers,” by Jerry Ellig and Jesse Martinez.)

The FTC’s letter is another example of how the agency can take steps using its advocacy tools to explain to state and local policymakers how their laws may be protectionist and anti-consumer in character. Needless to say, this also has ramifications for how the agency approaches parochial restraints on entry and innovation affecting the sharing economy.

In our forthcoming Mercatus Center comments to the FTC for its June 6th sharing economy workshop, Christopher Koopman, Matt Mitchell, and I will address many issues related to the sharing economy and its regulation. Beyond addressing all five of the specific questions asked in the Commission’s workshop notice, we also include a discussion about “Federal Responses to Local Anticompetitive Regulations.” Down below I have reproduced the current rough draft of that section of our filing in the hope of getting input from others. Needless to say, the idea of the FTC aggressively using its advocacy efforts or even federal antitrust laws to address state and local barriers to trade and innovation will make some folks uncomfortable–especially on federalism grounds. But we argue that a good case can be made for the agency using both its advocacy and antitrust tools to address these issues. Let us know what you think.

The Federal Trade Commission possesses two primary tools to address public restraints of trade created by state and local authorities: advocacy and antitrust.[1]

Through its advocacy program, the Commission can provide specific comments to state and local officials regarding the effects of both proposed and existing regulations.[2] Commissioner Joshua Wright has noted that, “For many years, the FTC has used its mantle to comment on legislation and regulation that may restrain competition in a way that harms consumers.”[3] Thus, at a minimum, the Commission can and should shine light on parochial governmental efforts to restrain trade and limit innovation throughout the sharing economy.[4] By shining more light on state or local anti-competitive rules, the Commission will hopefully make governments, or their surrogate bodies (such as licensing boards), more transparent about their practices and more accountable for laws or regulations that could harm consumer welfare. However, to be successful, the Commission’s advocacy efforts depend upon the willingness of state and local legislators and regulators to heed its advice.^[5]

The Commission has already used its advisory role in its recent guidance to state and local policymakers regarding the regulation of ridesharing services. The Commission noted then that “a regulatory framework should be responsive to new methods of competition,” and set forth the following vision regarding what it regards as the proper approach to parochial regulation of passenger transportation services:

Staff recommends that a regulatory framework for passenger vehicle transportation should allow for flexibility and adaptation in response to new and innovative methods of competition, while still maintaining appropriate consumer protections. [Regulators] also should proceed with caution in responding to calls for change that may have the effect of impairing new forms or methods of competition that are desirable to consumers. . . .  In general, competition should only be restricted when necessary to achieve some countervailing procompetitive virtue or other public benefit such as protecting the public from significant harm.[6]

This represents a reasonable framework for addressing concerns about parochial regulation of the sharing economy more generally.

Unfortunately, in areas relevant to the regulation of the sharing economy (e.g., taxicab regulations and rules governing home and apartment rentals) anticompetitive regulations have remained on the books—and in some instances have expanded—in spite of more than 30 years of Commission comment and advocacy.[7]  In fact, as Public Citizen noted in a recent Supreme Court filing:

[M]any more occupations are regulated than ever before, and most boards doing the regulating—in both traditional and new professions—are dominated by industry members who compete in the regulated market. Those board member-competitors, in turn, commonly engage in regulation that can be seen as anticompetitive self-protection. The particular forms anticompetitive regulations take are highly varied, the possibilities seemingly limited only by the imaginations of the board members.[8]

In these instances, the Commission’s antitrust enforcement authority may need to be utilized when its advocacy efforts fall short with regard to regulations that favor incumbents by limiting competition and entry.[9] Many academics have endorsed expanded antitrust oversight of public barriers to trade and innovation.[10] As Commissioner Wright has argued, “the FTC is in a good position to use its full arsenal of tools to ensure that state and local regulators do not thwart new entrants from using technology to disrupt existing marketplace.”[11] He notes specifically that he is “quite confident that a significant shift of agency resources away from enforcement efforts aimed at taming private restraints of trade and instead toward fighting public restraints would improve consumer welfare.”[12] We agree.

The Supreme Court’s recent decision in North Carolina State Board of Dental Examiners v. Federal Trade Commission made it clear that local authorities cannot claim broad immunity from federal antitrust laws.[13] This is particularly true, the Court noted, “where a State delegates control over a market to a nonsovereign actor,” such as a professional licensing board consisting primarily of members of the affected interest being regulated.[14] “Limits on state-action immunity are most essential when a State seeks to delegate its regulatory power to active market participants,” the Court held, “for dual allegiances are not always apparent to an actor and prohibitions against anticompetitive self-regulation by active market participants are an axiom of federal antitrust policy.”[15]

The touchstone of this case and the Court’s related jurisprudence in this area is political accountability.[16] State officials must (1) “clearly articulate” and (2) “actively supervise” licensing arrangements and regulatory bodies if they hope to withstand federal antitrust scrutiny.[17] The Court clarified this test in N.C. Dental holding that “the Sherman Act confers immunity only if the State accepts political accountability for the anticompetitive conduct it permits and controls.”[18] In other words, if state and local officials want to engage in protectionist activities that restrain trade in pursuit of some other countervailing objective, then they need to own up to it by being transparent about their anticompetitive intentions and then actively oversee the process after that to ensure it is not completely captured by affected interests.[19]

Some might argue that this does not go far enough to eradicate anti-competitive barriers to trade at the state or local level that could restrain the innovative potential of the sharing economy. While that may be true, some limits on the Commission’s federal antitrust discretion are necessary to avoid impinging upon legitimate state and local priorities.

Over time, it is our hope that by empowering the public with more options, more information and better ways to shine light on bad actors, the sharing economy will continue to make many of those old regulations unnecessary. Thus, in line with Commissioner Maureen Ohlhausen’s wise advice, the Commission should encourage state and local officials to exercise patience and humility as they confront technological changes that disrupt traditional regulatory systems.[20]

But when parochial regulators engage in blatantly anti-competitive activities that restrain trade, foster cartelization, or harm consumer welfare in other ways, the Commission can act to counter the worst of those tendencies.[21] The Commission’s standard of review going forward was appropriately articulated by Commissioner Wright recently when he noted that, “in the context of potentially disruptive forms of competition through new technologies or new business models, we should generally be skeptical of regulatory efforts that have the effect of favoring incumbent industry participants.”[22]

Such parochial protectionist barriers to trade and innovation will become even more concerning as the potential reach of so many sharing economy businesses grows larger. The boundary between intrastate and interstate commerce is sometimes difficult to determine for many sharing economy platforms. Clearly, much of the commerce in question occurs within the boundaries of a state or municipality, but sharing economy services also rely upon Internet-enabled platforms with a broader reach. To the extent state or local restrictions on sharing economy operations create negative externalities in the form of “interstate spillovers,” the case for federal intervention is strengthened.[23] It would be preferable if Congress chose to deal with such spillovers using its Commerce Clause authority (Art. 1, Sec. 8 of the Constitution),[24] but the presence of such negative externalities might also bolster the case for the Commission’s use of antitrust to address parochial restraints on trade.

[1]     See Maureen K. Ohlhausen, Reflections on the Supreme Court’s North Carolina Dental Decision and the FTC’s Campaign to Rein in State Action Immunity, before the Heritage Foundation, Washington, DC, March 31, 2015, at 19-20.

[2]     Id., at 20. (“The primary goal of such advocacy is to convince policymakers to consider and then minimize any adverse effects on competition that may result from regulations aimed at preventing various consumer harms.”) Also see James C. Cooper and William E. Kovacic, “U.S. Convergence with International Competition Norms: Antitrust Law and Public Restraints on Competition,” Boston University Law Review, Vol. 90, No. 4, (August 2010): 1582, “Competition advocacy helps solve consumers’ collective action problem by acting within the regulatory process to advocate for regulations that do not restrict competition unless there is a compelling consumer protection rationale for imposing such costs on citizens.”).

[3]     Joshua D. Wright, “Regulation in High-Tech Markets:  Public Choice, Regulatory Capture, and the FTC,” Remarks of Joshua D. Wright Commissioner, Federal Trade Commission at the Big Ideas about Information Lecture Clemson University, Clemson, South Carolina, April 2, 2015, at 15, https://www.ftc.gov/public-statements/2015/04/regulation-high-tech-markets-public-choice-regulatory-capture-ftc.

[4]     Cooper and Kovacic, “U.S. Convergence with International Competition Norms,” at 1610, (“Competition agencies could devote greater resources to conduct research to measure the effects of public policies that restrict competition. A research program could accumulate and analyze empirical data that assesses the consumer welfare effects of specific restrictions. Such a program could also assess whether the stated public interest objectives of government restrictions are realized in practice.”)

[5]     Cooper and Kovacic, “U.S. Convergence with International Competition Norms,” at 1582, (“The value of competition advocacy should be measured by (1) the degree to which comments altered regulatory outcomes times (2) the value to consumers of those improved outcomes. For all practical purposes, however, both elements are difficult to measure with any degree of certainty.”).

[6]     Federal Trade Commission, Staff Comments Before the Colorado Public Utilities Commission In The Matter of The Proposed Rules Regulating Transportation By Motor Vehicle, 4 Code of Colorado Regulations, (March 6, 2013), http://ftc.gov/os/2013/03/130703coloradopublicutilities.pdf.

[7]     Marvin Ammori, “Can the FTC Save Uber,” Slate, March 12, 2013, http://www.slate.com/articles/technology/future_tense/2013/03/uber_lyft_sidecar_can_the_ftc_fight_local_taxi_commissions.html (noting that, “not only does the FTC have the authority to take these cities to impartial federal courts and end their anticompetitive actions; it also has deep expertise in taxi markets and antitrust doctrines.”) Also see, Edmund W. Kitch, “Taxi Reform—The FTC Can Hack It,” Regulation, May/June 1984, http://object.cato.org/sites/cato.org/files/serials/files/regulation/1984/5/v8n3-3.pdf.

[8]     Brief of Amici Curiae Public Citizen in Support of Respondent, North Carolina State Bd. of Dental Exam’rs v. FTC, (August 2014): 24.

[9]     Brief of Antitrust Scholars as Amici Curiae in Support of Respondent, North Carolina State Bd. of Dental Exam’rs v. FTC, (August 6, 2014): 24, (“Antitrust review is entirely appropriate for curbing the excesses of occupational licensing because the anticompetitive effect has a similar effect on the market—and in particular consumers—as does traditional cartel activity.”)

[10]   See Mark A. Perry, “Municipal Supervision and State Action Antitrust Immunity,” The University of Chicago Law Review, Vol. 57, (Fall 1990): 1413-1445; William J. Martin, “State Action Antitrust Immunity for Municipally Supervised Parties,” The University of Chicago Law Review, Vol. 72, (Summer, 2005): 1079-1102; Jarod M. Bona, “The Antitrust Implications of Licensed Occupations Choosing Their Own Exclusive Jurisdiction,” University of St. Thomas Journal of Law & Public Policy, Vol 5, (Spring 2011): 28-51; Ingram Weber “The Antitrust State Action Doctrine and State Licensing Boards,” The University of Chicago Law Review, Vol. 79, (2012); Aaron Edlin and Rebecca Haw, “Cartels by Another Name:  Should Licensed Occupations Face Antitrust Scrutiny?,” University of Pennsylvania Law Review, Vol. 162, (2014): 1093-1164.

[11]   Wright, “Regulation in High-Tech Markets,” at 28-9.

[12]   Wright, “Regulation in High-Tech Markets,” at 29.

[13]   North Carolina State Bd. of Dental Exam’rs v. FTC, 135 S. Ct. 1101 (2015).

[14]   Id.

[15]   Id. Also see Edlin & Haw, “Cartels by Another Name,” at 1143, (“Who could seriously argue that an unsupervised group of competitors appointed to regulate their own profession can be counted on to neglect their selfish interests in favor of the state’s?”); Brief Amicus of the Pacific Legal Foundation and Cato Institute, North Carolina State Bd. of Dental Exam’rs v. FTC, (August 2014): 3, (“Antitrust immunity for private parties who act under color of state law is especially problematic, given that anticompetitive conduct is most likely to occur when private parties are in a position to exploit government’s regulatory powers.”)

[16]   See Maureen K. Ohlhausen, Reflections on the Supreme Court’s North Carolina Dental Decision and the FTC’s Campaign to Rein in State Action Immunity, before the Heritage Foundation, Washington, DC, March 31, 2015, at 16, https://www.ftc.gov/public-statements/2015/03/reflections-supreme-courts-north-carolina-dental-decision-ftcs-campaign, (“states need to be politically accountable for whatever market distortions they impose on consumers.”); Edlin & Haw, “Cartels by Another Name,” at 1137, (“political accountability is the price a state must pay for antitrust immunity.)

[17]   See Federal Trade Commission, Office of Policy and Planning, Report of the State Action Task Force (2003): 54, (“clear articulation requires that a state enunciate an affirmative intent to displace competition and to replace it with a stated criterion. Active supervision requires the state to examine individual private conduct, pursuant to that regulatory regime, to ensure that it comports with that stated criterion. Only then can the underlying conduct accurately be deemed that of the state itself, and political responsibility for the conduct fairly placed with the state.”) This test has been developed and refined in a variety of cases over the past 35 years. See: California Retail Liquor Dealers Ass’n v. Midcal Aluminum, Inc., 445 U.S. 97 (1980); Cmty. Comm’ns Co., Inc. v. City of Boulder, 455 U.S. 40, 48-51 (1982); City of Columbia v. Omni Outdoor Advertising, Inc., 499 U.S. 365 (1991); FTC v. Ticor Title Ins. Co., 504 U.S. 621 (1992).

[18]   North Carolina State Bd. of Dental Exam’rs v. FTC, 135 S. Ct. 1101 (2015).

[19]   Edlin & Haw, “Cartels by Another Name,” at 1156. (“Requiring that the state place its imprimatur on regulation is at least better than the status quo, in which states too often delegate self-regulation to professionals and walk away.”) See also North Carolina State Bd. of Dental Exam’rs v. FTC, 135 S. Ct. 1101 (2015) (“[Federal antitrust] immunity requires that the anticompetitive conduct of nonsovereign actors, especially those authorized by the State to regulate their own profession, result from procedures that suffice to make it the State’s own.”).

[20]  Maureen K. Ohlhausen, Commissioner, Fed. Trade Commission, “Regulatory Humility in Practice,” Remarks of the American Enterprise Institute, Washington, D.C. (April 1, 2015).

[21]   Edlin & Haw, “Cartels by Another Name,” at 1094, (“state action doctrine should not prevent antitrust suits against state licensing boards that are comprised of private competitors deputized to regulate and to outright exclude their own competition, often with the threat of criminal sanction.”). See also Brief Amicus of the Pacific Legal Foundation and Cato Institute, North Carolina State Bd. of Dental Exam’rs v. FTC, (August 2014): 2, 21, http://www.americanbar.org/content/dam/aba/publications/supreme_court_preview/BriefsV4/13-534_resp_amcu_plf-cato.authcheckdam.pdf, (noting that courts “should presume strongly against granting state-action immunity in antitrust cases.  It makes little sense to impose powerful civil and criminal punishments on private parties who are deemed to have engaged in anti-competitive conduct, while exempting government entities—or, worse, private parties acting under the government’s aegis—when they engage in the exact same conduct. . . . “Whatever one’s opinion of antitrust law in general, there is no justification for allowing states broad latitude to disregard federal law and erect private cartels with only vague instructions and loose oversight.”)

[22]   Wright, “Regulation in High-Tech Markets,” at 7.

[23]   FTC, Report of the State Action Task Force, 44, (“an unfortunate gap has emerged between scholarship and case law. Although many of the leading commentators have expressed serious concern regarding problems posed by interstate spillovers, their thinking has yet to take root in the law. Such spillovers undermine both economic efficiency and some of the same political representation values thought to be protected by principles of federalism.”); Brief Amicus of the Pacific Legal Foundation and Cato Institute, North Carolina State Bd. of Dental Exam’rs v. FTC, (August 2014): 13, (“Allowing states expansive power to exempt private actors from antitrust laws would also disrupt national economic policy by encouraging a patchwork of state-established entities licensed to engage in cartel behavior. This would disrupt interstate investment and consumer expectations, and would have spillover effects across state lines.”) Cooper and Kovacic, “U.S. Convergence with International Competition Norms,” at 1598, (“When a state exports the costs attendant to its anticompetitive regulatory scheme to those who have not participated in the political process, however, there is no political backstop; arguments for immunity based on federalism concerns are severely weakened, if not wholly eviscerated, in these situations.”

[24]   See Adam Thierer, The Delicate Balance: Federalism, Interstate Commerce, and Economic Freedom in the Technological Age (Washington, DC: The Heritage Foundation, 1998): 81-118.

Earlier this week I posted an essay entitled, “Global Innovation Arbitrage: Commercial Drones & Sharing Economy Edition,” in which I noted how:

Capital moves like quicksilver around the globe today as investors and entrepreneurs look for more hospitable tax and regulatory environments. The same is increasingly true for innovation. Innovators can, and increasingly will, move to those countries and continents that provide a legal and regulatory environment more hospitable to entrepreneurial activity.

That essay focused on how actions by U.S. policymakers and regulatory agencies threatened to disincentivize homegrown innovation in the commercial drone and sharing economy sectors. But there are many other troubling examples of how America risks losing its competitive advantage in sectors where we should be global leaders as innovators looks offshore. We can think of this as “global innovation arbitrage,” as venture capitalist Marc Andreessen has aptly explained:

Think of it as a sort of “global arbitrage” around permissionless innovation — the freedom to create new technologies without having to ask the powers that be for their blessing. Entrepreneurs can take advantage of the difference between opportunities in different regions, where innovation in a particular domain of interest may be restricted in one region, allowed and encouraged in another, or completely legal in still another.

One of the more vivid recent examples of global innovation arbitrage involves the well-known example of 23andMe, which sells mail-order DNA-testing kits to allow people to learn more about their genetic history and predisposition to various diseases. Unfortunately, the Food and Drug Administration (FDA) is actively thwarting innovation on this front, as SF Gate reporter Stephanie Lee notes in her recent article, “23andMe’s health DNA kits now for sale in U.K., still blocked in U.S.“:

A little more than a year ago, 23andMe, the Google-backed startup that sells mail-order DNA-testing kits, was ordered by U.S. regulators to stop telling consumers about their genetic health risks. The Mountain View company has since tried to regain favor with the Food and Drug Administration, but it’s also started to expand outside the country. As of Tuesday, United Kingdom consumers can buy 23andMe’s saliva kits and learn about their inherited risks of diseases and responses to drugs.

While the FDA drags its feet on this front, however, other countries are ready to open their doors to innovators and their life-enriching products and services:

A spokesperson for the United Kingdom’s Medicines and Healthcare Products Regulatory Agency said the [23andMe] test can be used with caution. […]  “The U.K. is a world leader in genomics and we are very excited to offer a product specifically for U.K. customers,” Anne Wojcicki, 23andMe’s co-founder and CEO, told the BBC. Mark Thomas, a professor of evolutionary genetics at University College London, said in a statement, ”For better or worse, direct-to-the-consumer genetic testing companies are here to stay. One could argue the rights and wrongs of such companies existing, but I suspect that ship has sailed.”

That’s absolutely right, even if the FDA wants to bury it’s head in the sand and pretend it can turn back the clock. The problem is that the longer the FDA pretends it can play by the old command-and-control playbook, the more likely it is that American innovators like 23andMe will look to move offshore and find more hospitable homes or their innovative endevours.

This is a central lesson that my Mercatus Center colleague Dr. Robert Graboyes stressed in his recent study, Fortress and Frontier in American Health Care. Graboyes noted that if America failed to embrace the “frontier” spirit of innovation — i.e., a policy disposition that embraces creative destruction and disruptive, “permissionless” innovation — then our global competitive advantage in this space is at risk:

Moving health care from the Fortress to the Frontier may be more a matter of necessity than of choice. We are entering a period of rapid technological advances that will radically alter health care. Many of these advances require only modest capital and labor inputs that governments cannot easily control or prohibit. If US law obstructs these technologies here, it will be feasible for Americans to obtain them by Internet, by mail, or by travel. (p. 41-2)

Graboyes highlighted several areas in which this issue will play out going forward beyond genomic information, including: personalized medicine, 3-D printing, artificial intelligence, information sharing via social media, wearable technology, and telemedicine.

As Larry Downes and Paul Nunes noted in a recent  Wired editorial, “Regulating 23andMe Won’t Stop the New Age of Genetic Testing“:

The information flood is coming. If not this Christmas season, then one in the near future. Before long, $100 will get you sequencing of not just the million genes 23andMe currently examines, but all of them. Regulators and medical practitioners must focus their attention not on raising temporary obstacles, but on figuring out how they can make the best use of this inevitable tidal wave of information.

American policymakers must accept that reality and adjust their attitudes and policies accordingly or else we can expect to see even more global innovation arbitrage — and a correspondingly loss of national competitiveness — in coming years.

[ Note: Our friends over at TechFreedom launched a Change.org petition awhile back to call for a reversal of the FDA’s actions.]

Additional Reading:

• Robert Graboyes on What the Internet Can Teach Us about Health Care Innovation (11/10/14)
• Thinking about Innovation Policy Debates: 4 Related Paradigms (11/11/14)
• New Paper on Privacy & Security Implications of the Internet of Things & Wearable Technology (11/21/14)
• Europe’s Choice on Innovation (12/2/14)
• Permissionless Innovation: The Continuing Case for Comprehensive Technological Freedom (2014)
• [Video] Cap Hill Briefing on Emerging Tech Policy Issues (June 2014)
• Why Permissionless Innovation Matters (4/24/14)
• How We Learn to Cope with Technological Change (6/30/14)
• Problems with Precautionary Principle-Minded Tech Regulation & a Federal Robotics Commission (9/22/14)

Patrick Byrne, CEO of Overstock.com, discusses how Overstock.com became one of the first online retail stores to accept Bitcoin. Byrne provides insight into how Bitcoin lowers transaction costs, making it beneficial to both retailers and consumers, and how governments are attempting to limit access to Bitcoin. Byrne also discusses his project DeepCapture.com, which raises awareness for market manipulation and naked short selling, as well as his philanthropic work and support for education reform.

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Related Links

• For Overstock CEO, Bitcoin Isn’t Just A Publicity Stunt, Forbes
• Meet Patrick Byrne: Bitcoin Messiah, CEO of Overstock, Scourge of Wall Street, Wired
• UBS, in Theory, a Conspiracy to Naked Short “Tens of Millions” of Shares, Deepcapture

[The following essay is a guest post from Dan Rothschild, director of state projects and a senior fellow with the R Street Institute.]

As anyone who’s lived in a major coastal American city knows, apartment renting is about as far from an unregulated free market as you can get. Legal and regulatory stipulations govern rents and rent increases, what can and cannot be included in a lease, even what constitutes a bedroom. And while the costs and benefits of most housing policies can be debated and deliberated, it’s generally well known that housing rentals are subject to extensive regulation.

But some San Francisco tenants have recently learned that, in addition to their civil responsibilities under the law, their failure to live up to some parts of the city’s housing code may trigger harsh criminal penalties as well. To wit: tenants who have been subletting out part or all of their apartments on a short-term basis, usually through web sites like Airbnb, are finding themselves being given 72 hours to vacate their (often rent-controlled) homes.

San Francisco’s housing stock is one of the most highly regulated in the country. The city uses a number of tools to preserve affordable housing and control rents, while at the same time largely prohibiting higher buildings that would bring more units online, increasing supply and lowering prices. California’s Ellis Act provides virtually the only legal and effective means of getting tenants (especially those benefiting from rent control) out of their units — but it has the perverse incentive of causing landlords to demolish otherwise useable housing stock.

Again, the efficiency and equity ramifications of these policies can be discussed; the fact that demand curves slope downward, however, is really not up for debate.

Under San Francisco’s municipal code it may be a crime punishable by jail time to rent an apartment on a short-term basis. More importantly, it gives landlords the excuse they need to evict tenants they otherwise can’t under the city’s and state’s rigorous tenant protection laws. After all, they’re criminals!

Here’s the relevant section of the code:

Any owner who rents an apartment unit for tourist or transient use as defined in this Chapter shall be guilty of a misdemeanor. Any person convicted of a misdemeanor hereunder shall be punishable by a fine of not more than $1,000 or by imprisonment in the County Jail for a period of not more than six months, or by both. Each apartment unit rented for tourist or transient use shall constitute a separate offense.

Here lies the rub. There are certainly legitimate reasons to prohibit the short-term rental of a unit in an apartment or condo building — some people want to know who their neighbors are, and a rotating cast of people coming and going could potentially be a nuisance.

But that’s a matter for contracts and condo by-laws to sort out. If people value living in units that they can list on Airbnb or sublet to tourists when they’re on vacation, that’s a feature like a gas stove or walk-in closet that can come part-and-parcel of the rental through contractual stipulation. Similarly, if people want to live in a building where overnight guests are verboten, that’s something landlords or condo boards can adjudicate. The Coase Theorem can be a powerful tool, if the law will allow it.

The fact that, so far as I can tell, there’s no prohibition on having friends or family stay a night — or even a week — under San Francisco code, it seems that the underlying issue isn’t a legitimate concern about other tenants’ rights but an aversion to commerce. From the perspective of my neighbor, there’s no difference between letting my friend from college crash in my spare bedroom for a week or allowing someone I’ve never laid eyes on before do the same in exchange for cash.

The peer production economy is still in its infancy, and there’s a lot that needs to be worked out. Laws like those in San Francisco’s that circumvent the discovery process of markets prevent landlords, tenants, condos, homeowners, and regulators from leaning from experience and experimentation — and lock in a mediocre system that threatens to put people in jail for renting out a room.

Last week, the Mercatus Center released “Bitcoin: A Primer for Policymakers” by yours truly and Andrea Castillo. In it we describe how the digital currency works and address many of the common misconceptions about it. We also analyze current laws and regulations that may already cover digital currencies and warn against preemptively placing regulatory restrictions on Bitcoin that could stifle the new technology before it has a chance to evolve. In addition, we give several recommendations about how to treat Bitcoin in future.

As I say in the video that accompanies the paper, Bitcoin is still very experimental and it might yet fail for any number of reasons. But, one of those reasons should not be that policymakers failed to understand it. Unfortunately, signs of misunderstanding abound, and that is why we wrote the primer.

For example, New York Superintendent of Financial Services Benjamin Lawsky recently made headlines after his office subpoenaed two-dozen Bitcoin-related businesses and investors. He went on CNBC’s Closing Bell to discuss his action, and here is how he answered the host’s question, “Have you seen specific evidence, or do you sense that there is illegal activity going on using Bitcoin?”

We know it from the Liberty Reserve case, a major indictment that came down recently. Six billion dollars in transactions, clearly finding narco-terrorism. It’s something we’re deeply concerned about.

Huh? What does Liberty Reserve have to do with Bitcoin? In short, nothing. Liberty Reserve was a centralized currency almost assuredly designed to evade government control and facilitate illegal activity. Brian Krebs has had great coverage of that currency. For reasons we explain in the primer, Bitcoin makes a terrible currency for criminals relative to centralized currencies like Liberty Reserve and now WebMoney and Perfect Money. Yet journalists, members of the public, and policymakers very often lump them all together under the rubric of “virtual currencies,” and don’t appreciate the differences that have important ramifications for policy.

In short, before they consider making policy, we hope regulators will better understand Bitcoin and similar decentralized crypto-currencies. We hope our primer helps educate folks about the basics, and we know that we and many other in the Bitcoin community stand ready to answer any questions we can about this revolutionary new technology and its social and political implications.

Sherwin Siy, Vice President of Legal Affairs at Public Knowledge, discusses emerging issues in digital copyright policy. He addresses the Department of Commerce’s recent green paper on digital copyright, including the need to reform copyright laws in light of new technologies. This podcast also covers the DMCA, online streaming, piracy, cell phone unlocking, fair use recognition, digital ownership, and what we’ve learned about copyright policy from the SOPA debate.

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Related Links

• Sherwin Siy, Public Knowledge
• What the DMCA cell phone unlock ban means to you, Reardon
• Why The Library Of Congress Has A Lock On Your Phone, Henn

Adam Thierer, Senior Research Fellow at the Mercatus Center discusses his recent working paper with coauthor Brent Skorup, A History of Cronyism and Capture in the Information Technology Sector. Thierer takes a look at how cronyism has manifested itself in technology and media markets — whether it be in the form of regulatory favoritism or tax privileges. Which tech companies are the worst offenders? What are the consequences for consumers? And, how does cronyism affect entrepreneurship over the long term?

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Related Links

• A History of Cronyism and Capture in the Information Technology Sector, Thierer
• Video: A History of Cronysim and Capture in the Information Technology Sector, Thierer
• Adam Thierer Biography, Mercatus Center
• Adam Thierer on Anti-Tech Grump Evgeny Morozov, Thierer

Richard Brandt, technology journalist and author, discusses his new book, One Click: Jeff Bezos and the Rise of Amazon.Com. Brandt discusses Bezos’ entrepreneurial drive, his business philosophy, and how he’s grown Amazon to become the biggest retailer in the world. This episode also covers the biggest mistake Bezos ever made, how Amazon uses patent laws to its advantage, whether Amazon will soon become a publishing house, Bezos’ idea for privately-funded space exploration and his plan to revolutionize technology with quantum computing.

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Related Links

• One Click: Jeff Bezos and the Rise of Amazon.com, Brandt
• History of Google/About Google, Brandt
• Five minutes with Richard Brandt, Author of One Click, Ennyman

National Review today runs a pretty unfortunate article about Bitcoin in which the reporter, Betsy Woodruff, tries to live for a week using only bitcoins—a fun stunt already done by Kashmir Hill about two months ago. Aside from misrepresenting libertarianism, what’s unfortunate about the article is how Bitcoin is presented to NR’s readers, many of whom may be hearing about the virtual currency for the first time. Woodruff, who admits she doesn’t completely understand how Bitcoin works, nevertheless writes,

From what I can tell, the main reason Bitcoin has any practical value is the existence of Silk Road, a website that lets users buy drugs and other illegal material online. …

A lot of Bitcoin aficionados will probably take issue with my next point here, but I’m pretty sure history will eventually be on my side. My theory is that Silk Road is the Fort Knox of Bitcoin. Bitcoin, from what I can tell, isn’t valuable because of idealistic Ron Paul supporters who feel it’s in their rational self-interest to invest in a monetary future unfettered by Washington; Bitcoin is valuable because you can use it to do something that you can’t use other forms of currency to do: buy drugs online. As long as Bitcoin is the best way to buy drugs online, and as long as there is a demand for Internet-acquired drugs, there will be a demand for Bitcoin.

Woodruff is right that folks who understand Bitcoin will take issue with her because she’s demonstrably wrong. While it’s true that illicit transactions probably did help bootstrap the Bitcoin economy early on, we are way past the point where such transactions account for any sizable portion of the economy. It’s easy to put her “theory” to the test: Nicolas Cristin of Carnegie Mellon has estimated that Silk Road generates about $2 million in sales a month. The estimated total transaction volume for the whole bitcoin economy over the last 30 days is just over $770 million. So, Silk Road accounts for about 0.25% of bitcoin transactions—far from being the “Fort Knox of Bitcoin,” as Woodruff says. And to put that in perspective, the UN estimates that the illicit drug trade accounts for 0.9% of world GDP.

The fact is that Bitcoin is not only a revolutionary new payments system that potentially disrupts traditional providers and can help serve the billions of unbanked around the world, but it also has the potential to be a distributed futures or securities market, or a distributed notary service. This is why Peter Thiel’s Founders Fund and Fred Wilson’s Union Square Ventures are investing millions of dollars in Bitcoin startups. Should we really think that these investors have overlooked what Woodruff posits—that the only value of bitcoins is to buy drugs? No, and I hope NR updates its story.

Today I had the great pleasure of moderating a panel discussion at a conference on the “Virtual Economy” hosted by Thomson Reuters and the International Center for Missing and Exploited Children. On my panel were representatives from the Bitcoin Foundation, the Tor Project, and the DOJ, and we had a lively discussion about how these technologies can potentially be used by criminals and what these open source communities might be able to do to mitigate that risk.

The bottom line message that came out of the panel (and indeed every panel) is that the Tor and Bitcoin communities do not like to see the technologies they develop put to evil uses, and that they are more than willing to work with policymakers and law enforcement to the extent that they can. On the flip side, the message to regulators was that they need to be more open, inclusive, and transparent in their decision making if they expect cooperation from these communities.

I was therefore interested in the keynote remarks delivered by Jennifer Shasky Calvery, the Director of the Treasury Department’s Financial Crimes Enforcement Network. In particular, she addressed the fact that since there have been several enforcement actions against virtual currency exchangers and providers, the traditional banking sector has been wary of doing business with companies in the virtual currency space. She said:

I do want to address the issue of virtual currency administrators and exchangers maintaining access to the banking system in light of the recent action against Liberty Reserve. Again, keep in mind the combined actions by the Department of Justice and FinCEN took down a $6 billion money laundering operation, the biggest in U.S. history.

We can understand the concerns that these actions may create a broad-brush, reaction from banks. Banks need to assess their risk tolerance and the risks any particular client might pose. That’s their obligation and that’s what we expect them to do.

And this goes back to my earlier points about corporate responsibility and why it is in the best interest of virtual currency administrators and exchangers to comply with their regulatory responsibilities. Banks are more likely to associate themselves with registered, compliant, transparent businesses. And our guidance should help virtual currency administrators and providers become compliant, well-established businesses that banks will regard as desirable and profitable customers.

While it’s true that FinCEN’s March guidance provides clarity for many actors in the Bitcoin space, it is nevertheless very ambiguous about other actors. For example, is a Bitcoin miner who sells for dollars the bitcoins he mines subject to regulation? If I buy those bitcoins, hold them for a time as an investment, and then resell them for dollars, am I subject to regulation? In neither case are bitcoins acquired to purchase goods or services (the only use-case clearly not regulated according to the guidance). And even if one is clearly subject to the regulations, say as an exchanger, it takes millions of dollars and potentially years of work to comply with state licensing and other requirements. My concern is that banks will not do business with Bitcoin start-ups not because they pose any real criminal risk, but because there is too much regulatory uncertainty.

My sincere hope is that banks do not interpret Ms. Shasky Calvery’s comments as validation of their risk-aversion. Banks and other financial institutions should be careful about who they do business with, and they certainly should not do business with criminals, but it would be a shame if they felt they couldn’t do business with an innovative new kind of start-up simply because that start-up has not been (and may never be) adequately defined by a regulator. Unfortunately, I fear banks may take the comments to suggest just that, putting start-ups in limbo.

Entrepreneurs may want to comply with regulation in order to get banking services, and they may do everything they think they have to in order to comply, but the banks may nevertheless not want to take the risk given that the FinCEN guidance is so ambiguous. I asked Ms. Shasky Calvery if there was a way entrepreneurs could seek clarification on the guidance, and she said they could call FinCEN’s toll-free regulatory helpline at (800) 949–2732. That may not be very satisfying to some, but it’s a start. And I hope that any clarification that emerges from conversations with FinCEN are made public by the agency so that others can learn from it.

All in all, I think today we saw the first tentative steps toward a deeper conversation between Bitcoin entrepreneurs and users on the one hand, and regulators and law enforcement on the other. That’s a good thing. But I hope regulators understand that it’s not just the regulations they promulgate that have consequences for regulated entities, it’s also the uncertainty they can create through inaction.

Ms. Shasky Calvery also said:

Some in the press speculated that our guidance was an attempt to clamp down on virtual currency providers. I will not deny that there are some troublesome providers out there. But, that is balanced by a recognition of the innovation these virtual currencies provide, and the financial inclusion that they might offer society. A whole host of emerging technologies in the financial sector have proven their capacity to empower customers, encourage the development of innovative financial products, and expand access to financial services. And we want these advances to continue.

That is a welcome sentiment, but those advances can only continue if there are clear rules made in consultation with regulated parties and the general public. Hopefully FinCEN will revisit its guidance now that the conversation has begun, and as other regulators consider new rules, they will hopefully engage the Bitcoin community early in order to avoid ambiguity and uncertainty.

Marc Hochstein, Executive Editor of American Banker,  a leading media outlet covering the banking and financial services community, discusses bitcoin.

According to Hochstein, bitcoin has made its name as a digital currency, but the truly revolutionary aspect of the technology is its dual function as a payment system competing against companies like PayPal and Western Union. While bitcoin has been in the news for its soaring exchange rate lately, Hochstein says the actual price of bitcoin is really only relevant for speculators in the short-term; in the long-term, however, the anonymous, decentralized nature of bitcoin has far-reaching implications.

Hochstein goes on to talk about  the new market in bitcoin futures and some of bitcoin’s weaknesses—including the volatility of the bitcoin market.

Download

Related Links

• VIDEO: Why Banks Should Care About Bitcoin, Hochstein
• Why Bitcoin Matters: It’s the Payment System, Stupid!, Hochstein
• Bitcoin vs. Big Government: How the virtual currency undermines government authority, Brito
• Online Cash Bitcoin Could Challenge Governments, Banks, Brito

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.]

Sadly, this situation isn’t going to improve any time soon. As I noted in a 2010 Cato essay (“The Sad State of Tech Politics“) and other essays here (see them below), lobbying by information technology companies is absolutely exploding. Google and Facebook set quarterly records of their own recently, but it’s not just the big dogs like them. Everyone is beefing up. As the politics of the parasitic Belwway economy increasingly replace the cut-throat rivalry of the market economy, consumers and innovation will suffer.

These firms aren’t coming to Washington because they are just dying to be here. They first come here out of necessity: they are looking to cover their asses. The more Washington seeks to regulate, the more these firms come to believe that they have to be here to make themselves heard. And I can’t blame them. But very quickly they come to realize that all this regulatory activity can present opportunities as well as threats. Regulation is often used as a club to beat back new innovations and rivals. Here’s the sad history of that. Worse yet, lobbying activity eventually takes on a life of its own.  As political scientist Lee Drutman points out in his dissertation on the business of lobbying, “lobbying creates its own demand… (and) has a self-reinforcing dynamic. Once companies come to Washington, they stick around, and usually expand. And with each passing year, more companies come to Washington”:

once they hire lobbyists and set up lobbying offices and become active in trade associations, they start to see the benefits of political participation. Lobbyists are there to point out new potential opportunities and new threats, and to make the case that being engaged politically is good for the bottom line. Companies get involved in more issues and more ongoing battles. And once they’ve paid the start-up costs of learning about Washington and building relationships, the cost-benefit equation of being politically engaged shifts even more in favor of staying and doing more.

In other words, there’s a sort of “Say’s Law” of lobbying at work: supply creates its own demand. That certainly seems to be true for the high-technology companies and sectors mentioned above. They are falling over themselves in a mad rush to see who can beef-up their lobbying operations faster. They are doing this even though there isn’t always a compelling case for them to be doing so. But it doesn’t make a difference. Lobbying has taken on a life of its own. It is rationalized by tech leaders telling themselves that ‘we either do this or we get screwed,’ all the while being egged on to do so by a professional class of inside-the-Betlway lobbyists, consultants, PR people, trade associations, and reporters who all insist that it’s just the way business is done nowadays — and who all make their money by encouraging the grow of the parasite economy.

Pathetic.

Additional (Miserable) Reading:

• “On Facebook “Normalizing Relations” with Washington” (March 29, 2011)
• “Kinsley on Cyber-Politics & ‘How Microsoft Learned the ABCs of D.C.‘” (Apr. 5, 2011)
• “The Internet, Politics, Lobbying & the ‘Big Spend‘” (Jan. 24, 2012)
• “FCC Commish Robert McDowell on Regulatory Failure & “Regulate My Rival” Politics” (June 28, 2012)
• “DC’s LivingSocial Cronyism Experiment Already Going off the Rails” (Nov. 29, 2012)

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. With information markets evolving at the speed of Moore’s Law, we should demand that public policy do so as well. We can accomplish that by applying Moore’s Law to all current and future laws and regulations through two simple principles:

• Principle #1 – Every new technology proposal should include a provision sunsetting the law or regulation 18 months to two years after enactment. Policymakers can always reenact the rule if they believe it is still sensible.
• Principle #2 – Reopen all existing technology laws and regulations and reassess their worth. If no compelling reason for their continued existence can be identified and substantiated, those laws or rules should be repealed within 18 months to two years. If a rationale for continuing existing laws and regs can be identified, the rule can be re-implemented and Principle #1 applied to it.

This would be a more effective way to get Internet over-regulation under control than any temporary moratorium. Again, if critics protest that some laws and regulation are “essential” and can make the case for new or continued action, nothing is stopping Congress from legislating to continue those efforts. But when they do, they should always include a 2-year sunset provision to ensure that those rules and regulations are given a frequent fresh look.

We often hear the legitimate complaint that ‘law can’t keep up with the Internet.’ It’s time we do something to act on that sound instinct. As I noted in concluding that earlier Forbes essay, only by demanding that regulations be sunset on a regular timetable can we keep government power in check and ensure unnecessary and outdated regulations don’t derail America’s high-tech economy.

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.

Download

Related Links

• Studio Neat
• Kickstarter
• It Will Be Exhilarating: Indie Capitalism and Design Entrepreneurship in the 21st Century, by Provost and Gerhardt

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.

That’s why the Marketplace Fairness Act is so troublesome. While indeed Congress has the power to create an state-to-state tax structure, it may be imprudent to do so.  In seeking to close what it disingenuously calls a “loophole” that allows Internet sales to remain tax-free, it bulldozes a vital element of commerce law that protects consumers from taxation from other jurisdictions.

And that protection is as necessary as ever. As the Tax Foundation’s Joseph Henchman will remind Congress today in his testimony, states have every incentive to shift tax burdens from their own residents to others elsewhere. As an example, take all those taxes attached to hotel and car rental bills.

The Marketplace Fairness Bill puts great stock in the idea that software and technology can relived the “burden” that, according to the courts, state and local tax compliance places on out-of-state business. But even sales tax complexity can’t be solved with the literal click of the mouse. It’s more than just the 9,600 sales tax jurisdictions that need to be factored in. Tax rules differ state to state, city to city and town to town. Sometimes a candy bar is taxed, sometimes it’s not. Every August, some states declare a “sales tax holiday weekend” in hopes of boosting back-to-school business. Dates can vary. Bottom line, there’s no reliable plug-and-play software for this. Overstock.com chairman and CEO Patrick Byrne has said it cost his company $300,000 and months of man-hours to create a solution.

The Marketplace Fairness Bill takes tax policy in the wrong direction, setting up a classic slippery slope that will see states becoming more and more predatory. What’s needed instead is an alternative that respects both state’s rights and the limits set by the Constitution.

But there will be no real progress until state legislators admit what they are trying to do: collect more taxes. That at least makes the dialogue honest. Then the question becomes whether the initiative is necessary to begin with. After that, more reasonable constructs include an origin-based tax system, building on the framework that exists today. When I purchase an item in Sugar Land, Tex, I pay sales tax to Texas and Sugar Land. When I travel to Los Angeles and buy a souvenir from the Universal Studios tour, I pat sales taxes levied there. A more sensible tax structure allows merchants to comply with the tax rules in their own states.

The only objection comes from legislators in high sales tax states who complain origin-based taxation gives businesses that locate in states such as Oregon and New Hampshire, two of five that charge no sales tax, an advantage. My affable reply is “Why yes, it does. Doesn’t it?.”

A low-tax policy is one way states can compete constructively for commerce and economic growth. Consumers and businesses would be much better off if states looked at e-commerce as an opportunity to boost their economies by welcoming Internet enterprises instead of treating them, and their customers, as just another cash pump.

For more, See “About that Sales Tax ‘Loophole'” 

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 10^th 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.]

Reason.org has just posted my commentary on the five reasons why Federal Trade Commission’s proposals to regulate the collection and use of consumer information on the Web will do more harm than good.

As I note, the digital economy runs on information. Any regulations that impede the collection and processing of any information will affect its efficiency. Given the overall success of the Web and the popularity of search and social media, there’s every reason to believe that consumers have been able to balance their demand for content, entertainment and information services with the privacy policies these services have.

But there’s more to it than that. Technology simply doesn’t lend itself to the top-down mandates. Notions of privacy are highly subjective. Online, there is an adaptive dynamic constantly at work. Certainly web sites have pushed the boundaries of privacy sometimes. But only when the boundaries are tested do we find out where the consensus lies.

Legislative and regulatory directives pre-empt experimentation. Consumer needs are best addressed when best practices are allowed to bubble up through trial-and-error. When the economic and functional development of European Web media, which labors under the sweeping top-down European Union Privacy Directive, is contrasted with the dynamism of the U.S. Web media sector which has been relatively free of privacy regulation – the difference is profound.

An analysis of the web advertising market undertaken by researchers at the University of Toronto found that after the Privacy Directive was passed, online advertising effectiveness decreased on average by around 65 percent in Europe relative to the rest of the world. Even when the researchers controlled for possible differences in ad responsiveness and between Europeans and Americans, this disparity manifested itself. The authors go on to conclude that these findings will have a “striking impact” on the $8 billion spent each year on digital advertising: namely that European sites will see far less ad revenue than counterparts outside Europe.

Other points I explore in the commentary are:

• How free services go away and paywalls go up
• How consumers push back when they perceive that their privacy is being violated
• How Web advertising lives or dies by the willingness of consumers to participate
• How greater information availability is a social good

The full commentary can be found here.

On Monday it was my great pleasure to participate in a Cato Institute briefing on Capitol Hill about “Internet Taxation: Should States Be Allowed to Tax outside Their Borders?” Also speaking was my old friend Dan Mitchell, a senior fellow with Cato. From the event description: “State officials have spent the last 15 years attempting to devise a regime so they can force out-of-state vendors to collect sales taxes, but the Supreme Court has ruled that such a cartel is not permissible without congressional approval. Congress is currently considering the Main Street Fairness Act, a bill that would authorize a multistate tax compact and force many Internet retailers to collect sales taxes for the first time. Is this sensible? Are there alternative ways to address tax “fairness” concerns in this context?”

Watch the video for our answers. Also, here’s the big Cato paper that Veronique de Rugy and I penned for Cato on this back in 2003 and here’s a shorter recent piece we did for Mercatus.

Reps. Jackie Speier (D-Calif.) and Steve Womack (R-Ark.) have introduced “The Marketplace Equity Act,” which would open the floodgates to anything-goes State-based taxation of the Internet and interstate commerce. The bill essentially sacrifices constitutional fairness at the alter of “tax fairness.” Building on concerns raised by state and local officials as well as “bricks-and-mortar” retailers, Speier and Womack claim that, as “a matter of states’ rights” and “leveling the playing field,” Congress should bless state efforts to impose sales tax collection obligation on interstate (“remote”) companies.The measure would allow States to do so using one of three rate structures: (1) a single blended state/local rate; (2) a single maximum State rate; or (3) the actual local jurisdiction destination rate + the State rate (so long as the State “make(s) available adequate software to remote sellers that substantially eases the burden of collecting at multiple rates within the State.”)

This builds on a long-standing effort by some States to devise a multistate sales tax compact to collude and impose taxes on interstate transactions. In the Senate, Sen. Dick Durbin (D-IL) has floated legislation (“The Main Street Fairness Act”) that would bless such a state-based de facto national sales tax regime for the Internet.

There is a better way to achieve fairness without sacrificing tax competition or opening the doors to unjust, unconstitutional, and burdensome state-based taxation of interstate sales. In a new Mercatus Center essay,”The Internet, Sales Taxes, and Tax Competition,” Veronique de Rugy and I argue that:

Apart from getting chronic state overspending under control, a better solution to the states’ fiscal problems than a tax cartel that imposes burdensome tax collection obligations on outof-state vendors would be tax competition.  Congress should adopt an “origin-based” sourcing rule for any states seeking to impose sales tax collection obligations on interstate vendors. This rule would be in line with Constitutional protections for interstate commerce, allow for the continued growth of the digital economy, and ensure excessive, inefficient taxes do not burden companies and consumers.

Vero and I have detailed this alternative plan in much greater detail in this 2003 Cato white paper, “The Internet Tax Solution: Tax Competition, Not Tax Collusion.” As we explain in our new paper:

In this system, states would tax all sales inside their borders equally, regardless of the buyer’s residence or the ultimate location of consumption. Under that model, all sales would be “sourced” to the seller’s principal place of business and taxed accordingly. This is, after all, how sales taxes have traditionally worked. A Washington, DC, resident who buys a television in Virginia, for instance, is taxed at the origin of sale in Virginia regardless of whether he brings the television back into the District. Each day in America, there are millions of cross-border transactions that are taxed only at the origin of the sale; no questions are asked about where the buyer will consume the good. Policy makers should extend the same principle to crossborder sales involving mail order and the Internet. Under this approach, Internet shoppers would pay the sales tax of the state where the online retailer is based.

An origin-based sourcing rule has several advantages over the destination-based system States favor.

1. It would eliminate constitutional concerns because only companies within a state or local government’s borders would be taxed.
2. An origin-based system would do away with the need for prohibitively complex multistate collection arrangements because states would tax transactions at the source, not at the final point of consumption.
3. An origin-based system also would protect buyers’ privacy rights, eliminating the need to collect any special or unique information about a buyer and to use third-party tax collectors to gather such information.
4. It would also preserve local jurisdictional tax authority whereas a harmonization proposal would create a de facto national sales tax system that would exclude local governments.
5. Finally, because it is more politically and constitutionally feasible, an origin tax may actually maximize the amount of tax collected for states by making compliance easier and incorporating currently untaxed activities.

In closing, it is important to address the misguided claim at the heart of the Speier-Womack bill that this is a “states’ rights” issue. Let’s be clear what real federalism is all about. Federalism is not about “states’ rights.” States have powers and responsibilities, and under the Constitution — at least the proper interpretation of it — they have wide-ranging flexibility to purse different governance approaches. But that power is not unlimited. America abandoned its first constitution, The Articles of Confedertion, after just 14 years in part because untrammeled state authority was discouraging interstate trade and commerce. In their wisdom, the authors or our present Constitution made sure to include Article 1, Sec. 8, Clause 3 — the so-called “Commerce Clause” — which created and protected what might best be thought of as the world’s first free trade zone – The United States of America. It remains one of the greatest achievements in constitutional and commercial history.

Thus, properly understood, federalism is about a healthy tension among competing units of government. Each has a different role and set of responsibilities, and this tension bolsters the checks and balances at the heart of our constitutional republic. [I outline all this in far more detail my 1999 book, The Delicate Balance: Federalism, Interstate Commerce and Economic Freedom in the Technological Age.]

In the context of Internet tax policy, this means that the tax power of the States can be legitimately constrained by the federal government to ensure that the interstate market is not unduly burdened with unjust levies. States certainly retain the power to impose whatever levies they wish on those actors who have a substantial physical presence in their geographic confines. That is, they can tax their own exports. Taxing imports from another State, however, is an entirely different matter, and one the necessarily requires some degree of federal oversight to ensure America’s free trade zone is preserved and protected.

An origin-based sourcing rule accomplishes that goal while also leaving States the discretion to impose taxes on their own exports if they so choose. The fact that this system would lead to heated tax competition among the States is a feature, not a bug.

Over the weekend, Janet Morrissey of The New York Times posted an excellent article on the U.S. government’s continuing crackdown on Internet gambling. (“Poker Inc. to Uncle Sam: Shut Up and Deal“) Ironically, her article arrives on the same week during which PBS aired the terrific new Ken Burns and Lynn Novick documentary on the history of alcohol prohibition in the United States. It’s a highly-recommended look at the utter hypocrisy and futility of prohibiting a product that millions of people find enjoyable. If there’s a simple moral to the story of Prohibition, it’s that you can’t repress human nature–not for long, at least, and not without serious unintended consequences. Which is why Morrissey of the Times notes:

And so the poker world now finds itself in a situation many liken to Prohibition. America didn’t stop drinking when the government outlawed alcoholic beverages in 1919. And, in this Internet age, it won’t be easy to prevent people from gambling online, whatever the government says. “It’s a game of whack-a-mole,” says Behnam Dayanim, an expert on online gambling and a partner at the Axinn Veltrop & Harkrider law firm. “They’ve whacked three very large moles, but over time, more moles will pop up.”

Exactly right (except that it should be “whac” not “whack”! There’s no K in whac-a-mole.)  It reminds me of the paper that my blogging colleague Tom Bell penned back in 1999 for the Cato Institute with its perfect title: “Internet Gambling: Popular, Inexorable, and (Eventually) Legal.” As Tom noted back then:

Consumer demand and lost tax revenue will create enormous political pressure for legalization, which we should welcome if only for its beneficial policy impacts on network development and its consumer benefits. We should also welcome it for a more basic reason: as the Founders recognized, our rights to peaceably dispose of our property include the right to gamble, online or off.

Again, you can’t hold back human nature and the effort of millions to pursue happiness as they see fit. It was true of alcohol and it will be true of online gambling–eventually.

And although it represents the worst argument for legalization, Tom was right about the tax revenue benefits as a primary factor leading to legalization. As Morrissey notes in her Times piece:

Uncle Sam is leaving a lot of money on the table. Over 10 years, legal online gambling could generate $42 billion in tax revenue, according to the Congressional Committee on Taxation. An estimated 1.8 million Americans played online poker last year, and some make a living at it. Because of the legal issues in the United States, online card rooms typically base their computer servers elsewhere, in places like Costa Rica or, in the case of Full Tilt, in the Channel Islands.

It was the same story back during alcohol prohibition, of course. All the “money left on the table” was snatched up by foreign governments and organized crime, who were all too happy to satisfy the thirst Americans had. Some State governments have already realized this and are taking steps to partially legalize online gambling and get in on the action, as Morrissey reports:

Oddly enough, Internet gambling is already legal in the nation’s capital. Earlier this year, the District of Columbia became the first jurisdiction in the United States to legalize it. Officials there said they hoped the move would bring in $13 million to $14 million a year in tax revenue. But Washington may only be the start. Several bills now working their way through the House of Representatives would give online poker the run of the country.

Again, as Bell’s paper argued, it’s popular, inexorable, and it will eventually be fully legal. We just have to be patient while some lawmakers play through this latest silly experiment in legislating morality.

States are ratcheting up legislation in order to capture sales taxes from on-line retailers, even as companies like Amazon.com aggressively push back.

A closely-watched bill in the Texas legislature that defines Amazon’s distribution center in Ft. Worth as a physical nexus, thereby obligating the on-line retailing giant to collect taxes on sales to residents of the Lone Star State, passed on a second go-through of this year’s session, overcoming an initial veto by Gov. Rick Perry.

The next move is up to Amazon. Its distribution center is essentially a warehouse that fulfills online orders and employs 200. Amazon previously said it would close the center if the bill passed, but has yet to make good on the threat. However, it is dangerous to dismiss it as a bluff. When South Carolina passed a similar bill, the company closed a distribution center there; only to return once the legislation was reversed.

The collection of taxes from on-line sales has become touchy among even the free-market-minded. Brick-and-mortar store owners have become increasingly vocal as to what they see as a purposeful scheme of “tax avoidance” that puts them at an unfair disadvantage against on-line retailers. Research, such as an April paper from the University of Tennessee’s Center for Business and E-Commerce Research, stoke the flames by calling the current sales tax rules a tax subsidy for online merchants.

The heart of the Texas dispute is whether a distribution center counts as a nexus. The case law is Quill Corp. v. North Dakota and National Bellas Hess v. Illinois Department of Revenue, which, as broadly understood, stipulate that a business must have a nexus, that is, brick-and-mortar store, in the state in order to be liable for tax collection. If there is a viable court test to either or both of these decisions, the contention that a distribution center constitutes a nexus may have the most potential.

Yet it’s not slam dunk. Quill, for example, says that in order to qualify as a nexus, the physical presence must be “significantly associated with business in the state.” The task of tax collection must also not present “an undue burden.” These are critical, because they tie back to the Commerce Clause of the U.S. Constitution that places limits the power of states to interfere with interstate commerce. While much of the argument for Amazon taxes relies on fairness, (hence, The Main Street Fairness Act), fairness was never an issue in Quill or National Bellas Hess. The rulings are about applying constitutional limits on the ability of governments, in the pursuit of tax revenues, to disrupt business operations.

Amazon argues that its fulfillment center is not significantly associated with business in the state. The Texas fulfillment center ships to neighboring states.  It also is not a consumer-facing storefront. It does not accept walk-in returns, nor will it replace or repair a defective product.

As for “undue burden,” it will do well to remember that collection of sales tax is a burden to start with. The states authorized collection at the point of sale out of realization there was no other way to capture that revenue (even now few consumers comply with use tax reporting requirements). In the spirit of enumerated powers, the Quill decision placed limits on states’ ability to deputize the private sector into tax collection. Quill protects businesses in one state from being preyed upon by others. Texas retailers may complain about Amazon, but their online sales to other states are not taxed.

Considering there are now more than 9000 sales tax jurisdictions in the U.S., compliance would still arguably be a burden, even in these days of the smartphone app.

Amazon also disputes claims from other trade groups, such as the International Council of Shopping Centers, that the lack of sales tax drive online sales. At the American Legislative Exchange Council’s annual meeting last week, Amazon officials NetChoice,  the e-commerce trade group, pointed to data from New York State, where, for purposes of documenting the effect, Amazon collects sales taxes. Purchases from Empire State residents have not declined, the company said, maintaining that Amazon’s advantage derives from lower prices and perks like free shipping.

That may be true to a great extent, yet it is somewhat disingenuous to suggest that sales tax avoidance isn’t part of the equation. As combined state, county and city sales taxes in some jurisdictions, like Chicago, Illinois, reach nearly 10 percent, consumer arbitrage becomes a factor. Here, a $500 item purchased on-line saves almost $50, no small sum.

But whose fault is that? Despite the reality that consumers can reach a global market with the click of a mouse, states, counties and cities chose to raid residents’ wallets again and again in their quest for revenues to offset bloated budgets. Even William Fox, a co-author of the University of Tennessee report mentioned above, argued at ALEC that on-line sales tax legislation should be accompanied by across-the-board cuts in sales tax rates. Yet it’s hard to imagine a legislature willing to make that trade-off.

Perhaps instead of railing against Amazon’s alleged “unfair” tax advantage, retailers should protest rising sales taxes in general. For now, like it or not, the law of the land is on Amazon’s side–and for sound constitutional reasons.