Taxing virtual property

A couple of years ago Professor Edward Castronova published a paper in which he calculated the GDP of Norrath, the virtual world on which Everquest is played. This calculation was done by looking at how many levels the average EQ player made per year, and how much virtual wealth in platinum pieces he earned. Castronova then calculated what a level was worth from the EBay sales price of EQ characters, and also looked at what the EQ platinum piece was worth, from different virtual currency sellers websites. He ended up with a GDP per person of over $2,000, which is as much as the GDP of Namibia.

I never liked that calculation. From an economist's point of view the calculation is flawed, because the Norrathian platinum piece is not a freely traded currency. The cost of this currency on EBay or from some gold farmer is not an exchange rate, but contains a relatively high transaction cost, and a risk premium for the seller, because he might get his account banned. Look at it that way: if you buy a decorative sea shell from Tonga for $10, you can't get the GDP of Tonga by multiplying $10 with the number of sea shells on the Tongan beaches. Calculating the value of a level is even worse, because there is no way to trade levels, you can only sell your whole account (a problem that is mentioned in the paper).

But of course if you believe that by playing a MMORPG somebody is earning a virtual currency which has a real world value, the inevitable consequence is that this constitutes a taxable income. And the crazy thing is that people are discussing that question on a big symposium, called the State of Play, organized by the folks from Terra Nova.

So lets assume in 2006 you leveled up 4 characters to 60 and made 10,000 gold. I looked at EBay, and it seems a level 60 character sells for around $200. The 10,000 gold would sell for around $500. So the IRS would state that you earned $1,300 of taxable income in World of Warcraft this year, even if you didn't sell your characters or gold. Because for the purpose of taxes, it doesn't matter whether you earned dollars, or something with a dollar value. And it doesn't matter that you spent the gold on epic mounts and items from the auction house, as long as you earned the gold in the first place it is taxable income. Pretty crazy, isn't it? You might end up paying more taxes on WoW than monthly subscription fees.

Fortunately there isn't much chance of that actually happening. The guys from Terra Nova are weird, and are taking their idea of humanity living in virtual worlds in the future too far. If the tax man would knock on your door today, you'd just show him the part of the WoW EULA where it states that all characters and items in game belong to Blizzard, not to the players. So, theoretically again, if anyone was liable for taxes on virtual earnings, it would be Blizzard. And I'd love to see their faces if the IRS comes and states that due to 7 million players each earning virtual property of $1,000, Blizzard has to pay taxes on $7 billion. :)

While taxing virtual property is far out, I'm pretty sure that if somebody sells WoW gold for dollars, that income already is taxable. This is independant of the consideration whether a virtual item is actually worth anything. If you sell Tarot card readings, which most people would consider worthless, you still have to pay taxes on whatever you earn from that. Now as World of Warcraft gold farmers already operate in shady territory I have my doubts that they are paying those taxes. That could lead to some sort of Al Capone moment, where the authorities are unable to charge somebody for the actual crime, but can still put him into prison for tax evasion.