Crypto assets that can be used as payment instruments have proliferated in more than 10,000 variations since the debut of Bitcoin in 2009, the first and still the largest. The staggering speed with which they have grown and the pseudonymity they can offer have left tax systems playing catch-up.
In a new paperwe discuss how governments can address the emerging challenges of taxing these crypto assets while their use is still limited, in order to avoid tax revenue leakage and protect the integrity of the tax system.
Classification of cryptocurrencies
Opinions on crypto assets are diverse and passionately held. The prospect of freeing financial transactions from the control of governments and the involvement of financial institutions is a libertarian dream for some.
El Salvador and the Central African Republic have gone so far as to adopt Bitcoin as legal tender.
Critics, however, view crypto assets not only as inherently worthless, but as a front for crime, scams, and gambling. They also highlight their dizzying volatility. Bitcoin, for example, rose from $200 a decade ago to almost $70,000 in 2021.
plunging at around $29,000 today.
The collapse of FTX last year and the United States Securities and Exchange Commission's recent lawsuits against
Binance And
Coinbase fueled user anxiety, while the lure of criminal activity resulted in high-profile multibillion-dollar seizures. These developments have attracted increasing attention from policy makers and
calls for regulation.
But whether crypto assets ultimately explode or crash, a consistent way to tax them is needed.
A key question is how to classify crypto assets: should they be considered property or currency? When crypto is sold for profit, capital gains must be taxed as they would be on other assets. And purchases made with crypto should be subject to the same sales or value-added taxes, or VAT, that would be applied to cash transactions.
An important task is therefore to ensure the application of these principles, which requires clarifying how to characterize cryptocurrencies for tax purposes: essentially, as currency for VAT and sales taxes and as assets for income tax purposes. Although this is not easy due to the evolving nature of crypto asset transactions, it is perfectly possible. The most important challenges then lie in the application of the law.
Income Considerations
Crude estimates suggest that a 20% tax on capital gains from crypto would have raised around $100 billion globally amid a price surge in 2021. This represents around 4% of global revenue of corporate tax, or 0.4% of total tax collection.
But with total market capitalization falling
63 percent from the peak at the end of 2021, tax revenues would then have decreased. If these losses were fully offset by other taxes, there would be a corresponding reduction in revenue. In more normal times and given the current size of the market, global tax revenues from cryptocurrencies would likely be less than $25 billion per year on average. All in all, it's not a huge amount.
Important questions of fairness are also at play. Although their pseudonymity makes it difficult to know exactly who owns crypto, there are signs that ownership is heavily concentrated among relatively wealthy people, although crypto holding is also surprisingly common among low-income people. Available surveys indicate that around 10,000 people hold a quarter of all Bitcoins.
There is also VAT. Cryptographic transactions have similarities to cash transactions in that they can be hidden from tax authorities. Today, the share of purchases made with cryptocurrencies is still low. But widespread use, if tax systems were not prepared, could one day lead to widespread evasion of VAT and sales taxes, resulting in a significant drop in government revenue. This is perhaps the biggest threat in crypto.
Address implementation
The most fundamental difficulty in taxing crypto assets is that they are “pseudonymous.” In other words, transactions use public addresses that are extremely difficult to link to individuals or businesses. This can facilitate tax evasion. Implementation is therefore at the heart of the tax authorities’ concerns.
The problem is surmountable when people transact through centralized exchanges, as these may be subject to standard “know your customer” tracking rules, and possibly withholding taxes. Many countries are implementing such rules in hopes of improving tax compliance.
However, reporting requirements could incentivize people to keep tax authorities in the dark by using centralized exchanges overseas instead. To address this concern, the Organization for Economic Cooperation and Development has developed a framework for exchanging crypto-related information between countries. However, implementation is still far away.
A more troubling possibility is that reporting rules (and the failures of some crypto intermediaries) could push people to increasingly transact through decentralized exchanges or directly through peer-to-peer exchanges where no central governing body does not supervise these transactions. It is still extremely difficult for tax administrators to enter.
Given the complexity of the fundamental challenges posed by pseudonymity, the speed of innovation, the vast information gaps and the uncertainties ahead, the tide has not yet turned in the battle to properly integrate crypto in the broader tax system. Some of the elements necessary for this, such as the clarity of their classification for tax purposes, are clear.
But the challenges are fundamental and the risks, particularly in terms of VAT and sales taxes, could be greater than we think. As many (but not all) governments are beginning to realize, policymakers must develop clear, consistent, and effective frameworks for taxing crypto.