Taxing Virtual Worlds
Today I came across the National Taxpayer Advocate’s annual report to Congress. The context for finding my way over there was an article over on another blog mentioning that the IRS may be considering taxing “virtual worlds” like Second Life and World of Warcraft. The report stops slightly short of recommending that the IRS actually contrive some way of imposing a virtual tax, but I was left with the general impression that the Taxpayer Advocate would like to see taxpayers shelling out real dollars to the IRS for each gold coin picked up in WoW. The Taxpayer Advocate points out a few reasons why such a scheme might be difficult to put into practice, but the report leaves out the myriad of reasons that taxing virtual worlds is a bad idea in the first place.
Volume 1, Section 13 of the report lays out the question of what the IRS should do with virtual worlds. That section is framed from the standpoint of asking the IRS to clarify points of confusion regarding when income taxes might arise from the transfer of property in a virtual world. Prior to reading the report, I would have thought the answer fairly straightforward: Converting your virtual goods into real goods (i.e., selling gold for dollars) is taxable, everything else is not. This rule is simple, intuitive, probably what almost everyone does anyway, and avoids the need for the IRS to promulgate new rules which are sure to be more harmful than the rule we have today.
The most obvious problem with taxing virtual worlds is figuring out how much each piece of virtual property is worth in terms of real dollars. The Taxpayer Advocate touches on some of the principle concerns with valuing virtual goods, including the fact that all virtual property is subject to forfeiture at the discretion of the virtual world operator and certain limitations imposed on the transfer of some virtual goods. In addition, unlike real goods which are limited in both quantity and lifespan, virtual goods can be created by virtual world operators at will, in any quantity, and do not deteriorate with time. This leaves virtual world operators uniquely able to affect the value of virtual goods by exercising nearly absolute control over supply at effectively zero cost.
One vitally important question that the Taxpayer Advocate does not address is which games would be subject to taxation. The report named World of Warcraft and Second Life explicitly, but made no suggestion that the taxing authority could or should be limited to those games. The outer bounds of reason require that taxes can only apply to games which are persistent; a game like Starcraft, in which the entire world expires when one player wins or all players exit, cannot rationally be said to confer income on a player. WoW and Second Life are both Massively Multiplayer Online Games (MMOs), so MMOs would certainly fall within the tax. But what of Multi-User Dungeons (MUDs), or smaller scale online roleplaying games like Diablo? Does the popularity of the game matter? Does a game need to have an interface to the real world market, such as people who actually want to buy and sell game items on eBay?
But perhaps the most important consideration that the Taxpayer Advocate should have kept in mind is that imposing a tax on virtual worlds will almost certainly destroy the entire market for online gaming. Most people buy and play games for the purpose of entertainment. In that sense, no matter how well a player may do in-game, nearly everyone will find that gaming is best viewed as an expense. Adding a tax on items in the virtual world itself would serve only to add the stress of bureaucracy to what should be a fun venture — imagine the frustration of needing to figure out if you have enough money in your real world bank account to pay for a random sword you picked up on the dungeon floor.
Hopefully, the Taxpayer Advocate’s brain-twisting “confusion” will remain buried deep within the bureaucratic nest from which it came. Nobody is well served by the expansion of the government’s tax authority into the realm of things which do not even exist.