Monday, October 16, 2006

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The economics of worlds colliding

I have never played World of Warcraft, Second Life, or any other simulated online game -- the closest I've come was my year-long semi-addiction to Civilization II.

However, for some reason I'm in the middle of one of those punctuated equilibrium in which I become inundated with information about a phenomenon that I was only dimly aware of before the equilibrium was achieved.

So I'm going to inflict all these links on you.

1) Reuters' Adam Pasick reports that the market for virtual goods is beginning to draw the attention of real-world tax authorities (hat tip: Greg Mankiw):

Users of online worlds such as Second Life and World of Warcraft transact millions of dollars worth of virtual goods and services every day, and these virtual economies are beginning to draw the attention of real-world authorities.

"Right now we're at the preliminary stages of looking at the issue and what kind of public policy questions virtual economies raise -- taxes, barter exchanges, property and wealth," said Dan Miller, senior economist for the Joint Economic Committee of the U.S. Congress.

The increasing size and public profile of virtual economies, the largest of which have millions of users and gross domestic products that rival those of small countries, have made them increasingly difficult for lawmakers and regulators to ignore.

Second Life, for example, was specifically designed by San Francisco-based Linden Lab to have a free-flowing market economy. Its internal currency, the Linden dollar, can be converted into U.S. dollars through an open currency exchange, making it effectively "real" money.

Inside Second Life, users can buy and sell virtual objects from T-shirts to helicopters, develop virtual real estate, or hire out services ranging from architecture to exotic dancing. Up to $500,000 in user-to-user transactions take place every day, and the Second Life economy is growing by 10 to 15 percent a month....

The rapid emergence of virtual economies has outstripped current tax law in many areas, but there are some clear-cut guidelines that already apply. For example, people who cash out of virtual economies by converting their assets into real-world currencies are required to report their incomes to the U.S. Internal Revenue Service or the tax authority where they live in the real world.

It is less clear how to deal with income and capital gains that never leave the virtual economy, income and capital gains that in the real world would be subject to taxes.

2) Indiana University's Joshua Fairfield and Edward Castronova have a draft paper entitled, "Dragon Kill Points: A Summary Whitepaper.":
This piece briefly describes the self-enforcing and non-pecuniary resource allocation system used by players in virtual worlds to allocate goods produced by a combination of player effort (the effort required to organize a group and overcome challenges) and the game itself (which “generates the good” – the input here is the time of the design staff).
3) Finally, I stumbled upon the South Park take on the whole World of Warcraft phenomenon. I got to see the entire episode before it was deleted for copyright reasons. This clip provides a nice precis of the show, however:

That is all.
posted by Dan on 10.16.06 at 10:39 AM


Leeroy Jenkins!

posted by: Johnny Upton on 10.16.06 at 10:39 AM [permalink]

Brad DeLong: "There was a time when I had to decide whether to be a Civilization addict or an economics professor"

posted by: Polybius on 10.16.06 at 10:39 AM [permalink]

Oh, wait, it gets much better.

Adam Pasick is actually now Reuters's virtual correspondent in Second Life. As in, Reuters has opened a bureau there.

Story, ironically, via BBC News:

posted by: JMB on 10.16.06 at 10:39 AM [permalink]

The episode is still actually availanle from Google video:

posted by: JS on 10.16.06 at 10:39 AM [permalink]

Our civil servants and it looks like our economists seem to have nothing better to do that think about taxing "virtual worlds".

I played Stock Ticker as a kid and NEVER did the SEC think that they should get involved. I played Risk and the Atomic Energy Commission nor International Court think that they needed to check on my weapons or treatment of captives. I play monopoly and collected rent and it was actually paper not "virtual" money and the IRS never had anyone (that I know of) think that they should tax my profits.


posted by: Ian Power on 10.16.06 at 10:39 AM [permalink]

Erm... it does get taxed.

All of those 'virtual worlds' require a subscription fee. Those fees are paid with taxed income, and the company being paid pays taxes on it's revenue.

While I am confident that if there is anything there to tax, the IRS will find it, I am more than a little unclear on exactly what is there to tax.

Is the government going to start taking a share of the virtual gold pieces dropped by critters in WoW?

posted by: rosignol on 10.16.06 at 10:39 AM [permalink]

It seems to me that taxing "income and capital gains that never leave the virtual economy" would be exactly equivalent to taxing one's Monopoly winnings. If you pass Go and collect $200, do you have to file a 1040? (Yes, I know there are taxes within the Monopoly world.)

posted by: David Nieporent on 10.16.06 at 10:39 AM [permalink]

Taxing virtual income sounds silly, or at least like an abstruse, tax-review-level concern. However, a few obvious analogies suggest themselves. First, consider how barter for intangibles or services should be taxed. Second, consider whether unrepatriated tax haven income of a US resident should be taxed. In the first case, there's at least some psychological value that may have some economic measure. In the second, there's the psychological value of the unrecognized gain that could occur on conversion.

These examples suggest line-drawing possibilities for virtual economic activity.

One more analogy: virtual economic activity uses a private currency, much like securities transactions. Should there be exceptions to the general rule of conversion-equals-recognition, as with securities?

Just asking.

posted by: CS on 10.16.06 at 10:39 AM [permalink]

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