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Charles Leadbeater predicts that taxes as we know them are doomed

We will be a nation of smugglers in the next century. Electronic smugglers, that is. It used to be said that only death and taxes were certain. In future, it may be only death.

The growth of the Internet and electronic commerce, combined with the globalisation of trade and production and shifts in the job market, spell the end for the 20th century's tax system. One of our most fundamental connections to government and public services - how we pay our taxes - is going to change for ever. Tax avoidance used to be the preserve of the rich. In the next century it will become a national pastime.

Party politics in the UK is still largely a competition over tax. Gordon Brown's commitment to keep personal income taxes at or below the rates set by the previous government was widely hailed as crucial to Labour's election victory. The ' public's willingness to pay a little more is constantly polled and debated. All that feverish argumentation is rapidly becoming irrelevant.

The best tax, from the state's point of view, is one that is simple to collect. An effective tax system must feed upon the way an economy generates wealth and it must also bear upon things that people cannot easily hide. The system of Anglo-Saxon England, designed to pay "Danegeld" to the invading Vikings, was highly efficient because it was based on a fixed rate per "hide", or unit of land. Not only was land impossible to conceal, it was also the source of income and wealth. A land tax made sense for a primarily agrarian society. Late Victorian England, by contrast, was primarily a manufacturing economy. Many people were employed by large companies; taxes on their wages became feasible thanks to the emergence of the modern corporation and its wages department. Capital and labour, rather than land, were the sources of wealth.

Now look forward, not even 100 years, but ten or 20. Perhaps 70 per cent of the UK economy will be made up of services. Most output will be immaterial, difficult to measure or touch. A growing share of transactions will be conducted over the Internet, leaving no physical trail. Experiments with electronic cash will be well under way. Advances in information technology and communications will allow production to be ever more international. Both capital and skilled labour will be more internationally mobile.

At the other end of the scale, more people on the margins of employment will be paid in cash; their earnings will go unrecorded. Our tax system, designed for an industrial world, will be outmoded. Industrialisation shifted the tax base from land to capital and labour. The new economy will require equally fundamental change.

Our tax system, like so many other economic institutions, is designed for a postwar industrial order. Two features of that old economy, which were vital to the state's ability to collect taxes, are disappearing fast. First, large employers, banks and building societies acted, in effect, as subcontractors to the Inland Revenue. They collected taxes on its behalf by docking our wages or the interest on our savings. Most of the tax collected in the UK came through these large, bureaucratic intermediary organisations.

This private-sector tax collection machine will not exist in future. Between 1979 and 1997, the number of self-employed grew from 1.9 to 3.3 million. At the start of 1996 there were 3.7 million enterprises in the UK, an increase of 1.3 million since 1980. Of these, 2.5 million had no employees. Micro-enterprises employing fewer than five people accounted for 89 per cent of all businesses in 1994. The Inland Revenue, a large, bureaucratic organisation, was at its most effective when it was collecting taxes from other large, bureaucratic organisations. It will find life much harder in future.

Second, the postwar tax system was built on a stable social base. Full employment created a steady flow of income. The nuclear family was the basic unit for tax assessment. But long-term unemployment and the growth of temporary and part-time work have undermined one side of this equation, and a variety of social forces, including divorce and a large rise in women's employment, the other. The tax base is becoming increasingly diverse and individualised, and so more costly to police.

Further, the benefits system encourages people in workless households to earn their livings in the shadow, cash-in-hand economy. Well-off professionals may work in the digital economy, but they pay their cleaners, plumbers, nannies and builders with used five-pound notes. This is one reason why demand for hard cash is booming. Even as electronic money arrives, old-fashioned cash is still an effective way to avoid tax.

Yet these are not the hungriest jaws gnawing at the foundations of the industrial tax system. The globalisation of trade and production, combined with the growing dematerialisation of the economy, are far more important.

Capital and skilled labour are increasingly mobile. Financial capital - our savings - can be shifted around the world within seconds, often several times a day. Industrial capital is also highly mobile. A couple of years ago Jurgen Schrempp, the chairman of Daimler-Benz, warned members of the German upper house of parliament that the price of keeping the company's factories in the country would be a tax bill of zero. In the 1970s large US corporations earned only about 15 per cent of their revenues from abroad; now it's close to 50 per cent.

Then there is skilled labour. Swedish companies such as Ericsson recently blamed high marginal tax-rates for an outflow of top technologists to the US. Silicon Valley, with its low Californian taxes, sucks in software engineers from around the world. More and more companies are imitating Nike, which organises production along extended global networks of subcontractors. The complementary networks of transfer pricing and tax arrangements are equally complex.

Globalisation has been eroding the tax base at least since the 1970s, when capital controls were removed. Its impact will be even stronger when it is combined with the growth of electronic commerce and the rise of the intangible economy. Start by considering the Internet. At present, people who shop on the net mainly use it to order tangible products. Instead of buying a CD or video from a shop, you go on-line and buy it from a mail-order service in the US, which then posts the product to you. If you were buying in the high street, the purchase would attract VAT; over the Internet it almost certainly will not.

This leakage of VAT could turn from a trickle to a torrent as more products become intangible. Computer bytes and digital information, sounds and images do not have to travel in containers or pass through ports where they can be scrutinised by customs officers. They can be transmitted down telephone lines and by satellite to personal computers. Our homes will become increasingly like minifactories, equipped to replicate software, download videos, reprint books, make compact discs. This trade will escape the taxman - unless he is installed as a program on a semiconductor put in every computer sold in the UK, a prospect that would alarm civil libertarians.

The tax authorities might fondly hope that companies doing business over the Internet will help them by becoming the tax collectors of the future, just as large employers, banks and building societies were in the past. They are almost certain to be disappointed, at least to begin with.

The Internet should give many smaller traders direct access to international markets. A small record label, based in Sheffield, which provides on-line music worldwide, cannot be expected to remit. taxes to scores of different governments. Just as important, a growing amount of trade will be conducted not over the Internet but over private intranets, run by large corporations to organise their suppliers and distributors. In this new world, how can it even be determined which government is entitled to tax? A consumer in Essex could download software made in Seattle, marketed via a website in California and delivered by a serve: located in the Bahamas. Where should this transaction be taxed?

Further, the dematerialisation of trade will remove one of the tax authority's most useful cross-checks on assessments: inputs and outputs. Take software and videos. As long as a company distributes software on floppy disks, the tax authorities can check the number of blank disks the company purchases and can use that as a guide to how much software it sells. But when a program can be downloaded in seconds over the Internet, like Adobe Acrobat or Netscape Navigator, there is no physical check on the scale of the trade.