Editor’s note: Today’s contributor is Solveig Singleton, senior policy analyst for the Project on Technology and Innovation, at the Competitive Enterprise Institute. C:\SPIN is produced by CEI.

WASHINGTON,Paypal has been in the news lately. In this case, a Missouri prosecutor sent Ebay a letter insisting that its recent acquisition, Paypal, was violating the Patriot Act by processing payments from Internet gambling operations.

Internet gambling is illegal in the U.S., but about 5 million Americans use overseas sites; Ebay discontinued Paypal’s gambling operations last fall. This comes on top of troubles Paypal has had with the New York attorney general and authorities in other states.

So what’s up with Paypal? Is something sinister going on there? Far from it. Prosecutors may get paid by the public, but they don’t always serve the public.

Paypal is a prime example of the amazing innovation one sees in unregulated markets responding to consumer demand.

Back in the mid-1990’s, everyone was speculating about digital cash. Digital cash would be stored on plastic cards carried in our wallets; it would enable “micro-payments” for goods and services on the Internet. It could be made traceable in varying degrees to control fraud, or untraceable, to become a law enforcement nightmare. As it was, digital cash has not really caught on in the United States; cash cards did much better in Europe. The most probable reason is that in the United States long distance communications are cheaper and credit cards much more widely available than in many parts of Europe. So it was easier and more efficient to come up with a payment system that piggybacks on existing credit and banking institutions than to come up with a digital cash infrastructure from scratch.

Delivering digital cash

Enter Paypal, which hooks up to your bank account or existing credit card to let you make a payment to anyone else with an e-mail address and a Paypal account. It satisfied the consumer desire to make micropayments. But it also solved a more serious problem…how to quickly make payments for an Internet auction without sending cash in the mail or sending a total stranger your credit card number or a check. From the standpoint of sellers, it solved the problem of how to accept payments without taking a check from a total stranger or dealing with the expensive apparatus of credit card acceptance.

And Paypal offers a money-back guarantee against fraud or disappointment in the purchase of goods for just a few dollars per transaction. Paypal is not a perfect solution to the problem of fraud online; people still get ripped off in online auctions. But they are far more secure using Paypal than checks, cash, or credit cards, while enjoying substantial net savings on goods bought through Ebay. (One of the reasons I am so enthusiastic about Paypal is that I’m a huge fan of online auctions, despite the occasional disappointment).

And Paypal’s or Ebay’s guarantee option may be the only real remedy for online auction fraud out there. Most of the fraud involves amounts less than $500, with a substantial amount being for less than $200 or even smaller amounts. Prosecutors and police rarely pursue cases involving such small amounts, and seldom track electronic offenders over state lines.

But police are interested in pursuing larger amounts of money, especially when they can seize it and keep it. And this may well be what is underlying state prosecutor’s interest in Paypal’s past role in gambling. The Patriot Act provisions that Paypal allegedly violated bar the transmission of funds known to have come from criminal activity. And they also provide for civil forfeiture. Whether Paypal could actually be convicted is questionable; Ebay argues that they acted in good faith.

Temptation of forfeiture laws

The Missouri prosecutors sent a settlement offer along with their letter. Maybe Paypal broke the law, and maybe they didn’t. Assume, for a moment, that our law against gambling is justified it and those that are breaking it are doing something wrong (an assumption that probably wouldn’t stand close examination). Paypal is certainly less involved in the wrongful transaction than those who actually gambled. But civil forfeiture means that prosecutorial discretion will be directed not at the actual wrongdoers (under our assumption, gamblers or gambling businesses), but businesses caught up with them because they offer services to everyone without inquiries into the exact nature of their business.

So again the weight of the law comes down on Paypal, despite the amazing service they offer at extraordinarily low cost. And with every layer of litigation and regulation comes costs that they must eventually pass on to consumers, and also a little less courage to experiment next time.

Will this zeal for prosecutions only stop when every computer company is as staid and cautious as the phone company? It would be one thing if the law served consumers, or targeted dangerous criminals. But as long as prosecutors and police are tempted by forfeiture laws, law enforcement will remain divorced from ordinary concepts of individual responsibility and the civil servant’s duty to the public. And it will begin to look a lot more like legalized extortion.

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