NewsLink V2N4 Summer 1998: From the Executive Director

Nicholas Negroponte, founder and director of MIT's Media Lab, likes to tell a story about the 19th century scientist Michael Faraday. A politician once asked Faraday whether the electricity he was studying in his laboratory would have any application in the real world. In what would become a famous remark, Faraday replied: “Sir, I do not know what it will be good for. But of one thing I am quite certain - someday you will tax it.”

Imagine, for a moment, that 30 years ago, the young scientists working on a network at Bolt, Beranek & Newman were asked the same question. Their work on ARPANET, a Department of Defense plan to connect computers between college campuses, would evolve into the Internet of today. The BBN scientists' response might have been reminiscent of Faraday's: “The bits moving back and forth across the globe may defy the laws of physics, but no doubt someday someone will want to tax them.” More than 160 years after Faraday's observation, politicians, like butterfly catchers, still aim to make a trophy of “The Next Big Thing.” The Internet represents an important opportunity for commerce and hence a potentially important source of tax revenue.


With the Internet, taxpayers could track the performance of the providers to which they make their contributions and policymakers could track the effectiveness of charitable tax credits for ending poverty.

When several members of Congress came up with the Internet Tax Freedom Act, which would impose a “time out” on Internet taxes, some state and local officials were worried. Ohio Governor George Voinovich, chair of the National Governor's Association and a man who has never met a tax he didn't like, declared that the act “represents the most significant challenge to state sovereignty that we've witnessed over the last ten years.” To secure passage, supporters have diluted the proposal to get the NGA on board. But the urge to tax is still there and will be after the act's three-year limit has expired.

The Internet Tax Freedom Act worries politicians like Governor Voinovich because it is as much a threat to the power to tax as it is a potentially lucrative source of new revenue. Taxing Internet commerce is as hard as squaring a circle. As Negroponte explained, “Taxes in the digital world do not neatly follow the analog laws of physics, which so conveniently require real energy, to move real things over real borders, taxable at each stage of the way.” Bits, he says, “by their very nature defy taxation.” This isn't exactly what the governing class likes to hear.

Ira Goldman pointed out recently in the Wall Street Journal that telecommunications providers are moving out of the business of providing phone service and into that of providing information bits, with phone service packaged with fax service, Internet access and other nontraditional telecommunications services. Government has traditionally imposed excise taxes on phone service. But there are practical as well as potential legal obstacles (especially under any Internet Tax Freedom Act) to taxing information bits. If government does seriously attempt to tax the Internet, the cost thus imposed, according to Goldman, will “freeze the technology, distort the workings of the market and stunt economic growth.”

There's a clear lesson here for policymakers, particularly in Massachusetts, where Alexander Graham Bell invented the telephone and where cutting-edge telecommunications firms generate $43 billion in sales and employ 90,000 people. Massachusetts is home to more than 2,500 software firms employing 122,714 people. According to the Massachusetts Software Council, 58% of the software companies in Massachusetts employ ten or fewer people and 88% are privately held.

Massachusetts stands to gain more than most states from a world without bit taxes. This means changing the state's ingrained tax-and-spend mentality. Internet taxes anywhere would be bad for Massachusetts. And Internet taxes anywhere are bad for the states or localities that try to impose them. As Lawrence Kudlow notes, “Governments are left to execute, but markets will dictate the direction of policy. It is a relentless process, but one that gives voice to ordinary men and women around the world who desire economic growth and social progress.”

The Internet telecommunications revolution represents a challenge to universities as well as to government. "The discipline of colleges and universities is in general contrived, not for the benefits of the students, but for the interest, or more properly speaking, for the ease of the masters,” wrote Adam Smith in The Wealth of Nations. One consequence of the Internet is that the “discipline of colleges and universities” will, by necessity, be contrived, not “for the ease of the masters” but for that of the students and of the ultimate consumers of university research.

The old way was for universities to generate ideas and then market them through teaching, books, journals or independent think tanks. Scholars would write and teach about issues like tax policy, and the world would wait as the ideas of these scholars made their way into the policy process.

The new way will be for universities to get the ideas directly to consumers. This means bypassing the intermediaries. It means, as it always has, the application of state-of-the art econometric and statistical methods. But it also means disseminating the results of these applications directly to students, policymakers and other ultimate consumers through the Internet.

Consider what the Internet has done to the travel industry. Formerly, travelers had to rely on intermediaries – travel agents – to find the best deals in air travel. Now they can go online to shop for travel bargains and to offer their own bids for open seats. The Internet has made it possible to reduce the cost of getting information to consumers and has made the travel business more price competitive. At the Beacon Hill Institute at Suffolk University, we are using our web site to get the results of our econometric and statistical research directly to our consumers. We are developing “EduNet” for high school and college students and teachers seeking instant access to information on the issues. In this process, the Internet simultaneously erodes the power of government to tax and provides the ideal vehicle for disseminating information on the economic consequences of taxes.

It also provides a vehicle for restructuring social institutions. Traditionally, for example, social-services providers have operated at the fringe of the welfare system, providing services that supplement government cash grants, food stamps, housing and job training services and the like. A better way would be to put private providers at the center of the welfare system permitting them to take over from government the primary responsibility for helping the poor. The way to accomplish this is to offer taxpayers credits (“charitable tax credits”) for their contributions to private, nonprofit providers. That would give taxpayers the power to place their funds with those providers that are most effective in helping the poor.

With the Internet, taxpayers could track the performance of the providers to which they make their contributions, and policymakers could likewise track the effectiveness of charitable tax credits for ending poverty. The Internet facilitates the elimination of yet another middleman, in this instance, the government welfare bureaucracy.

There are, to be sure, limitations to the power of the Internet for solving societal problems. No computer can convince a mother that she needs to acquire job skills or a child that he needs to do his homework. This approach to restructuring social services means giving taxpayers choices over where to send their welfare dollars. But it also means putting those dollars in the hands of providers (we call them “family advocates”) who understand and empathize with their clients.

The computer is revolutionizing the way we conduct commerce and communicate information. But as Adam Smith also said, “Consumption is the sole end and purpose of all production.” We might update this to read, “Improving the human condition is the sole end and purpose of all electronic computation.”