Don't Fear the Tax Man

Recently, in the thread that would not die, our esteemed colleague Ted Castronova raised the ominous possibility that real-world governments may soon be levying taxes on virtual-world transactions. In response it was noted that at least one highly profitable merchant of the virtual is already paying taxes on the dollars people pay him for his wares, but it seems what Ted was referring to was something more unsettling: the prospect that the IRS may decide to tax even in-game transactions -- where not a penny changes hands -- as a form of barter.

This sounds nutty, but it's definitely within the realm of possibility. Take a close look at the IRS rules on barter, as I did a few months back, and you'll see that once the fair market value of virtual items is acknowledged, there's really no form of in-game trade that can't, in theory, be taxed.

Having made that argument, however, I'd like to suggest that everyone now take a few deep breaths and repeat after me: In practice it's not going to happen.

Call it wishful thinking if you like, but give the tax system some credit. There are reasons barter is taxable, and among them is the risk that, if it weren't, significant portions of the economy might go underground, into an untaxable black hole of dollar-free wealth production. Now ask yourself: How much do virtual economies contribute to this risk of runaway revenue loss? Not a lot. Virtual economies can and do grow, but there's a limit to how much they can cannibalize the rest of the economy, and that limit is this: Until the day Domino's starts accepting EQ platinum for pizza deliveries, no one can actually live inside a virtual economy. Even then, pizza-for-plat will be as obviously and easily taxable transaction as dollars-for-plat already is -- and that should be enough to satisfy the IRS.

Not that the IRS is ever satisfied, of course. Wherever wealth is created, government likes to have its cut, and it could well decide that the $100 million or so in in-game transactions going on annually (at a very rough guess) is not beneath its dignity to pursue. I suspect, though, that it wouldn't take long for the government to reconsider.

Remember, after all, what happened on the eve of baseball slugger Mark McGwire's record-breaking home run 5 years ago: An IRS spokesperson, noting that the record-breaking ball would instantly be worth at least a million dollars, told the New York Times that whoever caught the ball and did the right thing (return it to McGwire) would instantly be subject to a gift tax of hundreds of thousands of dollars, at least according to the letter of U.S. tax law. The White House press secretary promptly declared this judgment "the dumbest thing I've ever heard" -- and the IRS duly issued a statement absolving the prospective ball catcher of any such liability.

The tax man doesn't much mind looking cruel and ham-fisted, apparently; but he hates to look ridiculous.

Comments

[Greg Lastowka]

1.

As I've told Julian before, IANATL (I am not a tax lawyer) -- I even avoided the quasi-mandatory tax law course all law students take.

However, I've been informally told by those who *are* tax lawyers that the issue of the taxation or non-taxation of virtual assets as acquired property interests is "interesting." (I'm not talking about taxing income here, which seems pretty clear even to me, but taxing acquired value in the form of virtual assets.)

My uninformed, uneducated guess is that perhaps this is one way that certain EULA provisions might work to the benefit of subscribers.

[Bob Kiblinger]

2.

Another interesting phenomenon would be the taxing of inventory for vaporware brokers. When I first went to my accountant back in 1999, that was one of the first things she asked - what is the estimated value of my current stock? She intended on having me pay taxes on the estimated worth of my inventory - which of course would have been disastrous (I have at least 50 active UO accounts most of the time - all loaded with goodies). She made a few calls to the IRS, and they decided it wouldn't be necessary at this time - so I breathed a sigh of relief :). I imagine that would be the first thing the government would realistically want to tax though - the inventory of re-sellers – which has already been assigned some worth in the eyes of the IRS since it was purchased with real life dollars.

[Bruce Boston]

3.

Ah, Too much fun! At least we have something to talk about for the next 25 years!

So, the closest I ever came to the law was a Japanese Law class I took while going to school in Tokyo, but I see several interesting arguments that could be made already.

Value Creation: My first thought was that if Virtual Brokers could be taxed on inventories, then we would have to assume that the Game Companies themselves could be taxed on their Game Inventories. Once we acknowledge that each item has a unique and predictable value then I wonder if the 'equipment' within a game doesn't begin to act more like the equipment within a gym, or the equipment in a RL Theme Park. Additionally, if the IRS, can claim that the second McGuire hit a Ball over the fence, instantly $1M in value was created, could they not also claim that the second the first Jedi was created that $1k in value was created? And if the EULA says that Sony owns the value that was created, are they not now liable for the taxes?

Time: Per Julian's writings on IRS Publication 525, the value of Time can be taxed. Since Time is exactly what is being paid for on 95% of eBay auctions, I would have to think that not only are items in VW's taxable, but also any Time sold, or purchased.

Ownership: But, this would bring us full circle to the question of ownership. Who owns what? and Can Players 'create value' in VWs? and, Do Players 'own' the value they create? and then, Do the Game Developers have the right to destroy, or deny access to, value that Players own?

I would have to think that if Players are able to create 'taxable' value that the IRS deems that they 'own' (which is why they are being taxed), that we start to bring other fun legal questions into play, like is it legal to block access to said 'owned property'?

Ah, too much fun!

-Bruce

[Edward Castronova]

4.

According to the Bureau of Labor Statistics, at

http://www.bls.gov/cex/home.htm

US consumer expenditures in 2001 came to $4.4 trillion. The money was spent on:
% Item
14 Food
33 Housing
04 Apparel
19 Transportation
06 Health
05 Entertainment
10 Insurance, pensions
09 Other

If the final limit is food expenditure, well, that leaves $3.7 trillion annually that might migrate to the synthetic economy. On the other hand, if only entertainment dollars and nothing else are likely to migrate, that's $218 billion.

Somewhere in between, there's a person who lives in a low-cost environment, spends little money on Earth housing, transportation, entertainment, and apparel, and instead devotes her income to the virtual equivalents of these. If this living pattern becomes widespread, the expenditure migration becomes a sizable chunk of change.

[Julian Dibbell]

5.

Nice breakdown, Ted. And when you put it that way, there's not even any reason to set the limit at food. To the extent that eating expenses pay for communion with friends and family rather than sheer sustenance, virtual economies can cut into those too.

To be honest, the more I think about it, the less I'm comforted by that part of my argument (the economic factors) than by the second part (the McGwire factor). To repurpose Jennifer Granick's argument from the Black Hat mock trial you testified at:

People all too frequently choose to stay home and have sex with one another rather than go out and keep money circulating in the economy. Moreover, the fair market value of a roll in the hay is easily established. So why not recover all that lost revenue by taxing sexual liaisons as a form of barter exchange?

And to quote learned authority on the McGwire conundrum: Because that's the dumbest idea I've ever heard, is why not.

Hopefully, in other words, "common sense" (by which I mean fairly root-level cultural norms) will compel tax judges to see MMOGs the same way they see sex: Some people do it for a living, and them we tax. The rest do it for something a lot like love, and them we wink at.

[Edward Castronova]

6.

Yeah, I agree with that. Let's hope the governments do stay sensible.

[Bruce Boston]

7.

Not sure if this is appropriate for this thread, but a very creative member has created a very serious tool to analyze the market breakdown in There.

www.ThereDaq.com

-Bruce

[Unggi Yoon]

8.

(Somewhat exorbitant from this subject, thogh...)

At present, the avatar has(or demand) only quasi-right, not quasi-duty/burden from the holding in-game items.

Imagine a gaming company(not goverment) impose progressive tax or charge(either virtual or real) on players according to the value/attributes of items they are holding, like that of property tax by real goverment.

Is that in-game taxation or charging in help of just and proper (Re)distribution of virtual world's resources and quench the overheating item trading in Real world?

Unggi Yoon