Taxation in a BitCoin Economy

With bitcoin (briefly) hitting a landmark figure of $1000 per bitcoin on some exchanges following the green light seemingly given by the US Senate Hearings, cryptocurrency is here to stay.  The transition to a bitcoin economy will see nation states and their governments face substantial challenges to revenue raising through taxation.  Where commerce is transacted in a pseudo anonymous cryptocurrency, income tax, one of the primary forms of taxation becomes nigh on impossible.  Only that which can be seized – such as physical property can be taxed, and people themselves cannot effectively be taxed on income, only on activities.

Where money creation is under the control of the Government, money is quite easy to track. Income tax is the primary vehicle for raising revinue from individuals, while corporation tax is the equivalent for companies. Transactions are taxed through Value Added Tax; transfer of wealth in the event of death taxed through Inheritance tax. Wealth in the form of property is taxed through Council Tax for individuals, and rates for businesses, while additional “added rights” taxes – such as the BBC licence fee which allows you the right to own a device capable of receiving the BBC realtime, and Road Tax which gives you the right to place a car that you own on a public road give you specific rights through national licences.

This is of course, very UK centric, but the same principles apply to almost every country. The bitcoin economy will change all that. The “anarcho-capitalists” (an oxymoron if ever there was one) will tell you that this is what is so great about Bitcoin. “It can’t be taxed!“, they cry – alluding to its psuedo-anonimity, which means that although full transaction records are publicly available, there is nothing necessarily that ties any given entity – be that an individual or a corporation – to a given wallet. Of course it can be taxed, the question just becomes how you tax when commerce is conducted in a pseduo- anonymous currency.

Tax is the primary mechanism by which governments raise money for the provision of goods and services in the interests of the citizens in whose name they govern. The question of whether that is what they actually do with the money that they raise is a moot point, or whether its distribution favours those who have greater influence within that population, but that is a whole other topic.  Other mechanisms are profits from nationalised industries, donations from international or regional entities, such as the EU or the World Bank and of course simply creating more through turning on the printing presses – a practice sanitised by the name “quantative easing” and sullied by the practice. But tax is key: its the primary financial relationship between the individual and the nation state.

At the moment, governments keep a close eye on money, any time money changes hands, a record must be kept – not only of the transaction, but also the individual recipient and donor. To fail to keep such records is illegal and money turning up in one place when it should have been in another is strongly frowned upon – at least for the little guy. Making money magically appear in one place from another is the domain of webs of international offshore companies and dodgy mafia organisations with money laundering fronts. For those without those means, there is little chance to escape taxes, excepting the occasional cash-in-hand Saturday girl who works without employment protections to benefit from a slightly higher rate of pay; the builder who works for cash-discounts; the imported cigarettes sold under the counter.  Under bitcoin, although the transactions are public, the entities behind them are untraceable. This has serious implications for the tax system.

Income Tax and corporation tax are in some ways the same thing, in that they are taxes on an entity on their income, individual income or corporate income in the form of profits. . Neither of these forms of taxation is sustainable in an economy where the majority of commerce is conducted through bitcoin. The wallet receiving money cannot necessarily be traced to an individual, nor can an individual be tied to any given wallet. Likewise for corporations. This form of taxation is effectively dead once bitcoin gains a grip as it cannot be effectively enforced. Attempts may well be made to regulate and force people to reveal their wallets, but such attempts are likely to be both resource intensive and ultimately futile as small scale fraud becomes overwhelming and people hide their financial identities.

What can be identified are transactions, very publically identified on the blockchain – the mass database which records all transfers of bitcoins from one wallet to another from the inception of bitcoin. But again taxing it is another issue. With no individuals identifiable behind the transaction, the question of how to tax these transaction becomes a question of who has control over them. And in this case, it is the miners. There is already a “transaction tax” built into bitcoin, in the form of fees. Fees are optional, but ensure swift processing of a transaction through prioritising the confirmations of a transaction to ensure that a coin is not spent twice. As bitcoin progresses, the rewards in the form of new coin creation lessen in relation to the proceeds from these fees, becoming a greater and greater part of the income of the miners. Effectively miners are taxing transactions as a reward for keeping the network up and running.This now effectively transfers the power over taxation on transactions to the miners, the nation state has no powers of this, particularly as bitcoin has no borders.

What can be taxed by governments is only that which can be seen, and only that which can be seized. Governments are geographic entities – they are formed from the nation state and its borders. Anything that physically – not digitally – lies within it can be taxed. Property taxes are likely therefore to be an increasing method that the government uses to raise revenue. Property taxes are already common – in the UK, council tax and rates – both notably local rates of taxation are the most predominant ones. These property based taxes are likely to be of increasing importance as goverments recognise the threat to their revenue that a bitcoin denominated commercial sector holds.

Rights based taxes, or government licences – such as the BBC licence fee, road tax, even public house licences, are also likely to grow in importance This is where the real and the digital world interface. Mining – although digital – is also a physical activity, servers are physical things which exist in meatspace, consuming energy, which is also a physical resource. As the only entity capable of taxing commerce it is likely that taxes or licences surrounding the bitcoin mining industry will be developed.Mining has come along way from its early days of teenage nerds in their bedrooms mining bitcoins in the backgrounds of their desktops. Today, in 2013, it is a specialist enterprise, requiring dedicated equipment, and mining pools, and shares in mining pools have become an industry in their own right. As the difficulty of mining and the transaction volume increases this trend is likely to carry on apace. While a server in a backroom can be easily hidden from the eyes of the authorities, vast mining fields are less easy to conceal.

The other thing which is directly identifiable and seizable are people themselves. Attempts at flat rate taxes on existence, such as the poll tax have always been doomed to failure, however people are taxed in the opposite form of “rights based taxes”, that is to say, they are fined when they act in a way that the government deems unacceptable. The imposition of fines is again likely to be a key revenue stream for the government, and one which is far easier to collect than taxes on incomes or on transactions, and far easier to enforce so long as the money for the prisons can be maintained.

I personally have no doubts that within a few years, bitcoin will be a major world currency, and within a decade, it will be the primary currency of commerce. Yet public goods will still need supplied and in the half-dozen years that this transition is likely to take, the nation state, although may see some fundamental blows to its revenue streams, is still the only entity capable of providing the public goods and services that are required.

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