Seth Rosenblatt/CNET

PALO ALTO, Calif. -- The impact of US government surveillance on tech firms and the economy is going to get worse before it gets better, leaders at some of the biggest tech firms warned US Sen. Ron Wyden on Wednesday during a roundtable on the impact of US government surveillance on the digital economy.

The senior Democratic senator from Oregon took the floor at the Palo Alto High School gymnasium -- where he played high school basketball well enough to earn a college scholarship for his court-side abilities more than 50 years ago -- to discuss the economic impact and future risks of US government surveillance on technology firms.

Google Executive Chairman Eric Schmidt, who has been outspoken on the topic, pulled no punches with his assessment of how the spying scandal has and will continue to impact Google and other tech companies.

The impact is "severe and is getting worse," Schmidt said. "We're going to wind up breaking the Internet."

Also on the panel with Schmidt was Microsoft General Counsel Brad Smith, another critic who became more outspoken of government surveillance after Edward Snowden leaked National Security Agency documents in 2013 that showed a much wider federal spying apparatus than previously believed.

"Just as people won't put their money in a bank they won't trust, people won't use an Internet they won't trust," Smith said.

Panelist Ramsey Homsany, general counsel for online storage company Dropbox, said the trust between customers and businesses that is at the core of the Internet's economic engine has begun to "rot it from the inside out."

"The trust element is extremely insidious," Homsany said. "It's about personal emails, it's about photos, it's about plans, it's about medical records."

The documents leaked by Snowden indicate that the US government has been collecting a record of most calls made within the US, including the initiating and receiving phone numbers, and the length of the call; emails, Facebook posts and instant messages of an unspecified number of people; and the vast majority of unencrypted Internet traffic including searches and social media posts. Documents from Snowden show that the British equivalent of the NSA, the Government Communications Headquarters (GCHQ), has a similar program.

Trouble abroad

In prepared remarks to open the roundtable, Wyden noted that he warned back in 2011 that people were going to be stunned and angry when they found out how the US government had been "secretly applying its surveillance authority" to its citizens. What he wasn't counting on was the international backlash.

Some of the international pushback is in response to data collection by tech companies, not the US government. Europe's new and controversial "right to be forgotten" law, which says European citizens have a right to ask search engines to remove any results that might infringe on their privacy, is causing headaches for Google. Critics contend that Google policies placed data collection over privacy.

The tech execs on the panel were most upset and scared about international efforts to impose "data localization," as Microsoft's Smith put it, referring to a burgeoning efforts by countries to force companies to build data centers based within their borders.

The cost of building data centers in each country that a tech firm wants to do business in could wind up destroying US tech firms, Schmidt and Smith warned.

Schmidt called data localization a "national emergency." Tech titans have yet to go in-depth as to the actual financial impact data localization has had on them, but in addition to the costs of having to build at least one separate data center for each country that demanded it, data localization could also subject the data to local laws in a way that tech firms worry would erode user trust -- and their ability to trade on that trust -- even further.

Smith noted that 96 percent of the world does not live in the US, and that the American tech economy depends on convincing them that American tech services are trustworthy. "Foreign data centers would compromise American [economic] growth" and leadership, he said.

Abroad, efforts are already underway to force international tech companies to be more respectful of their own national interests -- efforts that could erode consumer trust further, said Wyden. German Chancellor Angela Merkel has said publicly that Germany is looking at European email service providers so that their messages "don't have to go across the Atlantic." The government of Brazil's President Dilma Rousseff is considering forcing US tech firms to build data centers in Brazil, if they want to do business with Brazil.

The biggest indication of the decline of America's ability to guide the Internet, according to Wyden, is that Chinese officials told the senator earlier this summer that they considered the Chinese theft of US tech trade secrets no different than US government surveillance of foreign governments and firms.

Rebuilding trust

Part of reclaiming leadership in the digital economy since the Snowden document leaks has been efforts by tech companies to encrypt user data to protect it. Facebook has used its leverage to help convince tech companies to implement tougher webmail encryption standards, while Google and Yahoo are seeking to push the envelope of how encryption can safeguard webmail.

Panelist Colin Stretch, general counsel for Facebook, called efforts to encrypt user data "a key business objective of all of us."

"I'd be fundamentally surprised if anybody takes the foot off the pedal of building encryption into their products," he said.

Wyden reiterated his stance that he is not opposed to all government surveillance: He supports Section 702 of the Foreign Intelligence Surveillance Act Amendments from 2008, which allows the director of National Intelligence and the US attorney general to team up to target non-US citizens located outside the US.

While Wyden and the panelists discussed the need to revise American laws as the first step to regain the trust of American citizens and international governments, they didn't talk about what to do with the data that's already been collected.

Wyden told CNET after the panel that he had no plans at the moment to address the data that the government has currently collected.

"I have to reflect on that," he said, but added, "The cat's out of the bag. I want to get policies right for the future."

"There's no question that Washington, DC, does overreach well," quipped the senator.

Wyden concluded with a promise to make Congress take action to preserve the digital economy.

"The message here today is that there is a clear and present danger to the Internet economy," he said. "The reality is that we can pass a good bipartisan bill by the end of the year."

Update, 3:23 p.m. PT with additional information and background.