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Contest Essay

Does the New Economy Require a Free Economy?


     
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Third Prize ($1,000)

George Orwell looked to a future where the “autonomous individual” would be “stamped out of existence” by totalitarian governments wielding omnipotent technology.1 His dark vision was of a world in which technology would enslave mankind. Had he lived to see the way the post-war Soviet Union and other oppressive states used technology to keep their citizens in chains he might have deemed his prophecy a good one. Today it seems clear that technology has played a quite different role.

Those governments that sought to rigidly control the free-flow of information have died like beached whales. Most of them did not have the stomach to use the coercion needed to stop their systems from collapsing. Those that did found that even guns and tanks could only temporarily silence their own people while their economies slipped further and further behind the information-economies of the West. It’s one thing marching people at gunpoint to the Promised Land, but when the Promised Land you are marching them to looks like an English black-and-white film from the 1960s, then you aren’t going to win. Gorbachev may have been a dumb communist with a strange birthmark, but even he could see that the genie was out of the bottle. When you are so scared of free-flowing information that your photocopying machines have to be guarded by KGB officers, then you’re in big trouble and you might as well invent perestroika and glasnost.

If the writing was on the wall in 1989, then it is now written across the night sky in huge neon lights. The technology that has emerged over the last decade has entered so many people’s homes and has come together in such a way that governments are increasingly unable to monitor, control, or prohibit a growing number of activities. History is speeding up, change accelerating; if you are not swimming like hell you’re drowning. The meek will not inherit the earth, the quick and the smart will. Governments and bureaucracies play by rules that are fundamentally incompatible with the speed of technological change that will characterise this brave new world. Orwell’s hero, Winston Smith, would today be as likely to be hacking into Big Brother as being monitored by him.

The digital age changes the balance between governmental power and individual rights, in that it will be increasingly easy for people largely to ‘opt out’ if they are dissatisfied with a government2

The Internet and mass ownership of personal computers have established a global communications system that is beyond the control of any political entity. The Semiconductor Chip, aided by Public Key Encryption, has enabled individuals to move large amounts of information to anywhere in the world quickly in encrypted form; which has a degree of privacy governments cannot breach without massive effort. The Global Commodities Futures Market enables individuals to easily discover world commodity prices; governments no longer have the ability to deceive their citizens about the standard of living elsewhere.3 The emergence of digital money as an alternative to government currencies, and asset securitization, which enables more and more assets to serve as backing for private monies, promises to undermine governmental monopolies of money. Smart-cards that allow an individual to buy, sell, and save electronic money outside of banking systems and electronic communications systems, if they wish to do so, are already a reality. Add to these technologies the growing availability of very low-cost telecommunications — bandwidths are estimated to triple every year for the next 25 years — which enable usage to spread rapidly, and you have a revolution in financial privacy. These technologies are the foundation stones of the new economy. Individuals and businesses can move their money anywhere in the world at click-speed, without the knowledge of their governments. As these technologies have come together it has become apparent that far from being watched by an omnipotent ‘Big Brother’ we are entering an age of ‘digital liberation’.

The tools of economic growth in the new economy are also the tools of freedom. Governments cannot limit economic freedoms without putting the brakes on economic growth. The wide-dissemination of Information is now the engine of economic growth, governments cannot afford to restrict or control the technology without killing the goose that lays the golden eggs. Digital money, which has huge potential as the currency of the future, will only be used widely if it can be securely encrypted. E-commerce needs strong encryption. Otherwise information and digital money will be stolen or misused. Once it is encrypted financial privacy is a ‘technologically-driven certainty ’4. Governments that attempt to deny secure encryption will stop e-commerce reaching its full potential. If any privacy is granted then any secure information will inevitably be hidden through that channel. Financial privacy either exists or it doesn’t, and if it doesn’t then the new economy will not work. In fact, encryption technology is already too widely available for governments to deny its use. Digital money has so many advantages over printed governmental currency that it seems inevitable that it will soon be widely used. Digital cash transactions will be instantaneous, cutting out the loss of interest during slow transactions and will be much cheaper to service than governmental currency, which costs a fortune to print. The growing ease with which capital, people and businesses can be moved around will rapidly necessitate governments reforming old fashioned forms of taxation and regulation. Capital flight is already disciplining governments as bad policy decisions result in an immediate flood of capital being switched to more sensible economies5. Anything but low marginal tax rates will also be punished by capital flight. The perfectly legitimate wish to minimise your taxation within the law will see individuals shift capital around in ways that until now were only open to large businesses and rich individuals, which are already notoriously difficult to tax. Governments are increasingly going to know only what people want them to know about their finances. Internet banking will offer simple access, low transaction costs, a degree of anonymity, and the ability to move money around the world at click-speed. The high-skilled highly-paid workers that presently pay an unfair proportion of the tax burden in wealthy countries are those best placed to reap this whirlwind and as they relocate to more reasonable shores they will punish oppressive tax regimes heavily. Tax bases are going to shrink due to this technology, necessitating smaller government. Governments have a simple choice; offer a free economy with low taxes, financial privacy, a solid infrastructure and low crime, OR, try to deny their people the freedoms of digital liberation.

The early battles over the freedom of the new economy have already been fought, and there can be little doubt about who came out of the fight on top. An illuminating example of how governments have to surrender to digital liberation is the British gambling industry. The 1968 Gaming Act placed the British gambling industry in a legislative straitjacket. It banned casinos from advertising, offering credit, staging live entertainment or serving drinks at tables. No more than 10 slot machines were permitted in each casino, and each machine had to pay out any jackpot itself, taking up to 8 minutes to pay out onto the floor. This made the machines so heavy that casino floors needed to be strengthened. The contradictions of the legislation were absurd. Betting shops could not open on winter evenings but bingo halls could. The National lottery advertises but casinos were banned from doing so. A 9 percent gambling tax was levied on all off-course bets. A mandatory 24-hour ‘cooling-off’ period for new members of casinos had to be endured before they were allowed to place a bet. After all this it is a wonder that anyone in Britain could be bothered to gamble. But gamble they did. Eighty-nine percent of the population admits to gambling6 and the British gambling industry is reputedly worth 42 billion.

In the late1990s new technology changed everything. Until then gambling regulations and taxation had been enough of a deterrent for the British government to fool itself that nothing was wrong. Then in 1999 Ireland cut its betting tax from 10 percent to 5 percent. Irish bookmakers began putting their British rivals out of business with Internet and telephone betting services. British bookmaker Victor Chandler began an exodus to escape the betting tax by setting up his online service in Gibraltar, where he was soon being credited with being responsible for 7 percent of ‘the Rock’s’ economy. Victor Chandler also attracted many American customers, many of whom live in states where gambling is banned or highly regulated. Without assets in America the authorities cannot force Victor Chandler to comply with their gambling laws. Outflanking this prohibition simply requires opening an overseas bank account and gambling through it. Faced with a mass exodus of its bookmakers and a drying up of its revenue from betting tax the British government backed down. A Home Office review body created to look at this absurd state of affairs concluded that online gambling and offshore betting made the regulations and tax nonsensical. Gordon Brown’s finally announced the scrapping of the betting duty for 2002. It is now effectively impossible to prohibit gambling or tax it. The Internet is deregulating the global gambling industry and governments are powerless to stop it. Strong-arm tactics merely lead to a shrinking tax-base, as increasing numbers of people operate outside the law, and chase investment away to low-tax jurisdictions.

What the taxman cannot see, he cannot tax.
What the regulator cannot detect, he cannot regulate.7

The fate that has befallen gambling regulations and taxation in Britain is about to befall many other taxes and regulations. To tax authorities need to know the identity and location of an economic actor. If they do not know whom the economic actor was then how can they tax you? If they do not know where you are, or at least where your economic activity took place, how can they prove taxable activity took place inside their jurisdiction?8

The changing nature of work is creating huge problems for governments. With dozens or even hundreds of individuals, many of whom are self-employed consultants, working on the same projects from numerous locations around the globe physical location becomes meaningless. Traditionally countries taxed businesses which had a ‘permanent establishment’; but establishing where a website or server is located can be impossible9. We have a global economy with national taxes10, and whatever governments do in the future it will be much easier to hide in the shadows. Journalists are already writing about the ‘vanishing taxpayer11’.

Road-kill on the information super highway12’.

Global Internet retailers are undermining VAT collection. Faced with an 8.25percent sales tax on purchasing a book in a Manhattan bookstore or paying 0percent on the same book from Amazon.com the choice is easy13. The Internet retailers are committing massive tax evasion and government seems powerless to stop them14. In the EU online retailers are supposed to collect VAT at the rate where the purchase is consumed. This delightfully stupid piece of legislation is supposed to stop companies relocating to the member-state with the lowest VAT rates. A British taxman pointed out the flaw ‘If we visit a company in Britain and find that it is not charging VAT on goods it is shipping to, say, Germany, we will certainly tell them they are supposed to be charging German VAT. But it is not our job to enforce the collection of German taxes or to tell the German government that it is missing out.15’ Getting non-EU retailers to collect VAT on this principle is a non-starter. The emphasis is already turning towards monitoring physical goods as they enter ports and airports to see whether they have been taxed. The authorities hope to be able to pressure firms into charging customers in the first place. In 1996 the Dutch government ordered the post office to open all suspicious packages to stop CDs entering the country without paying VAT. Downloading music and swapping files ends even this kind of backlash. Taxing digital goods where they are consumed is almost impossible; no one will be able to tell where, when and what is being consumed. Taxing services has always been hard and the Internet is making it even harder. As bandwidths increase the ‘dematerialization of products’ will increase. Taxation relies upon information but digital technology makes it simple to hide information. Tax authorities still rely upon paper-based records, whereas the Internet encourages electronic records, which can be stored in some foreign jurisdiction. Likewise the growth of business-to-business transactions, cutting out middlemen, denies the authorities another crucial source of information. Tax authorities have tried to catch-up by trying to use shipping companies and credit card companies to collect taxable information but they have met with a stony response. In short the taxation of e-commerce faces technological constraints; tax laws are rigid whilst technology changes at lightning pace. The taxmen of the world are getting frustrated, as one remarked recently ‘They can move millions of dollars at the click of a mouse, and five years later, when we’ve changed the rules, they’ve come up with another scheme16’.

Can the enemies of freedom stop the new economy being a predominantly free economy? In a word NO. The clash between the record industry and information distribution networks like Napster is already making this very clear. Despite a huge effort by this vested interest group to create technology to protect copyrights - using everything from ‘content scrambling systems’ to ‘digital locks’, and from ‘cryptographic envelopes’ to pressurising PC makers to limit the technology on their products – they are doing little more than chasing the wolf’s tail. Despite legal decisions against Napster, which is primitive by comparison with the hybrids and clones that have followed it, music file swapping is going from strength to strength. There are now more than 50 of these services. Record company executives already admit their options are limited, as one remarked ‘your main demographic (people in their teens and early 20s) are stealing. You don’t know who they are. You don’t know where they are17’. There are, of course, limits upon the freedom offered by the new technologies and governments will aim at these in future. Many commodities cannot be downloaded and much consumption will remain visible. You cannot hide your house or you car from the taxman using this technology. Also, total financial privacy has costs as well as benefits. Total privacy is impractical; some transparency is needed to attract credit and investment. Also, freedom needs law and order; the New Economy will be no exception to this rule. People will be reluctant to move their capital to disreputable banks or retailers. However, self-regulation, similar to that exercised by Swiss banks, rather than cumbersome and inefficient government-organised policing is likely to emerge as the only workable model. Many people will accept some limitation upon their economic freedoms if that is the price of trying to capture criminals and paedophiles.

However, most attempts to limit economic freedom in the new economy will ultimately fail. The most governments can do is to outlaw activity without stopping it. In the old economy a great deal of regulation and taxation existed which was simply ignored and evaded. Many of the controlled economies were able to survive simply because massive shadow economies existed in stark contradiction to the law, enabling commodities to be traded. The economic reality was much more liberal than the legal reality. Many citizens within the new global economy will be able too engage freely in economic activity that is officially illegal within their countries. In this sense it may become irrelevant for many people whether their government permits them economic freedom. The technology in their PC will give them that freedom anyway.

Only that which can be taxed efficiently should be taxed at all’18

The ‘old’ economy ‘required’ a free economy too, but it rarely got it. The prophets of digital liberation have presented a vision of the future that is the triumph of hope over experience19. The logical implications of the technology driving the new economy are that governments can no longer control such huge spheres of economic activity, but to assess whether governments will act wisely faced with this challenge it is perhaps sensible to consider their track record.

Tax evasion is as old as taxation itself. Paying cash wages and failing to report taxable activity has always torn holes in the tax net, letting large numbers of fishes through. Collecting tax efficiently by coercion alone has rarely worked. The ability to ‘opt out’ of paying taxes that many predict will become endemic in the new economy is nothing new20. Many governments in the 20th century found efficient taxation almost beyond them21. According to one analyst the underground economy has grown three times as fast as the official one since the 1960s. Why? Largely as a result of excessive regulation of labour and product markets and an increasingly heavy tax burden. A massive tax wedge emerged between what a firm pays and what a worker receives22 creating a huge incentive to operate underground. The mind-boggling complexity of many tax systems encourages many workers to stay in the shadow economy. The growth of the service-sector, self-employment and part-time work has increased the ease with which many people can hide their economic activity.

The sensible answer to this global mess would be for governments to deregulate the labour market, lower taxes, and cut red tape, but governments are not good at sensible answers.

In a world full of taxes and regulations that are inefficient, unenforceable and damaging to wealth creation, governments rarely choose to solve their problems by reducing their sphere of interest. The prophets of digital liberation believe that technology will render taxation and regulation so inefficient and costly that governments will draw the logical conclusion and change their behaviour. Regulating the new economy will be much more difficult for governments than the old economy was, but you can be sure this will not stop governments attempting it. The entire history of taxation and regulation is one of governmental stupidity and attempts to fly in the face of economic wisdom. Will governments really be any wiser in the future?

The new economy will not witness the end of the battle between those who seek to control economies and those who wish free them; it will merely take it to a different plateau. Governments may be far less likely to win but they will be just as likely to try. As the man said ‘logic and taxation are not always the best of friends23’ Blinding governments is one thing, escaping their clutch another. Odysseus blinded the Cyclops by driving a stake into its eye, reducing the one-eyed-giant to thrash about wildly, reeking vengeance upon the unlucky. But Odysseus was still trapped in the cave. He had to outwit the Cyclops to escape. For many people this will be their experience of the new economy. Governments may be blind to much economic activity but they will stubbornly refuse to change their taxation systems, and the unfortunate few that they do catch evading oppressive tax laws and regulations will be put through the grinder. Odysseus and his men all ‘required’ freedom but only some of them actually got it.

Notes

1. Quoted in Orwell, Wintry Conscience of a Generation, Jeffrey Meyers, Norton & Company Ltd (2000) p. 207

2. Rahn, Richard W. The End of Money and the Struggle for Financial Privacy, Discovery Institute Press (1999) p. 183. Whilst I do not share all of Dr Rahn’s beliefs about the new economy I would not have been able to write this essay without his fascinating book.

3. Historians are already studying the role that TV played in undermining the legitimacy of former eastern block communist governments. Once visions of western opulence were being beamed into Polish tower blocks the game was up.

4. Rahn, Richard W. The End of Money and the Struggle for Financial Privacy, Discovery Institute Press (1999) p. lost.

5. In Russia, for example some estimates place ‘capital leakage’ in the year 2000 at $33 billion. Source; The Economist (Dec 7 2000) ‘Quiet Flows The Dosh’. High-tax, intrusive, regulation-prone countries will be punished even more ruthlessly in the future.

6. KPMG, an accountancy firm, researched British gambling habits and found that 89% of British adults had gambled in the last year. Of the 22 types of gambling listed in the study 20 were considered socially acceptable by a majority of respondents.

7. Rahn, Richard W. The End of Money and the Struggle for Financial Privacy, Discovery Institute Press (1999) p. 147

8. The American tax system taxes ‘global income’, which changes the problem to gathering information from outside the US.

9. Tax authorities are already trying to redefine their tax laws to try and cope with this. Luc Hinnekins, a lawyer at the University of Antwerp, has come up with the concept of ‘virtual permanent establishments’ whatever that means!

10. Some politicians in Europe are already touting the possibility of a world tax organisation. Someone should shoot them.

11. Bishop, Matthew. ‘The Mystery of the Vanishing Taxpayer’, The Economist (Jan 27 2000).

12. An anonymous record executive quoted in ‘The Happy E-Shopper’, The Economist (Jan 27 2000).

13. Purchasing the book from Amazon.com does of course require the customer to pay the P&P but most studies have shown there is still a discount of around 10%.

14. Contrary to public perception online retailing is not tax exempt in the US; there is simply no obligation upon the retailer to collect it. No one collects is it from e-commerce, this is mass tax evasion. Government attempts to collect sales taxes from Internet sales, and their inability to do so, merely discriminates against those not connected to the Internet. America is effectively an Internet tax haven, not according to the law, but in reality. ‘The Happy E-Shopper’, The Economist (Jan 27 2000).

15.‘The Happy E-Shopper’, The Economist (Jan 27 2000).

16. Quoted in ‘Net Losses’, The Economist (Jan 27 2000).

17. Shamoon, Talal, Senior Vice-President of Intertrust, quoted in ‘Siren Songs’, The Economist (Oct 5 2000).

18. Rahn, Richard W. The End of Money and the Struggle for Financial Privacy, Discovery Institute Press (1999) p. 161.

19. As a young historian it is my job to inject some objectivity and perspective into the debate, even if it spoils the party. You might think a young historian should mind his own business and leave the present and the future to young economists. You might be right.

20. French taxes were historically often only collected along the routes of the main roads, where the army could be used to enforce them. One can imagine a similar situation if governments insist upon unenforceable taxes on e-commerce. Tax has often relied upon the information provided by taxpayers. Income tax has often relied upon a citizen’s trustworthiness in declaring their annual income. The US tax system, for example, relies upon 120 million Americans submitting self-declaration tax forms. Government attempts to assess everyone’s assets have always been costly and inefficient. They required large numbers of people to co-operate with the system and when citizens failed to do so they had few answers; prosecution has always been selective many were guilty only a few were prosecuted.

21. A few quick examples; In Argentina in the 1990s it was estimated that 60% of taxes went uncollected. The Indian and Russian shadow economies are estimated to be as large as their official ones. Personal income tax revenue yields just 1.5% of GDP in India, perhaps unsurprising in a country where the income tax rate stood at 97.5% until recently . Even in relatively wealthy countries large numbers of people have avoided paying their taxes. In Spain, Belgium and Italy more than 20% of GDP goes unreported to the tax authorities.

22. In Italy and France the ratio is 3:1.

23. James C McReynolds, concurring in Sonneborn Bros. V. Cureton 1923.


James M. Rebanks is an undergraduate in Modern History at Magdalen College Oxford University.






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