In the midst of cryptocurrency’s upward revenue trajectory, an increasing concern arises on tax compliance and policy making in compensation to society. Despite some volatility, digital assets’ popularity continues to climb. With this, the tax reporting gap has also escalated resulting in a loss of at least $50 billion in revenue from crypto transactions.
Revolutionary new methods of crypto taxation, such as a crypto mining excise tax or the IRS wash sale rule, may seem promising, however, enhancing enforcement of untaxed transactions using existing policies may do more to close this gap.
Whistleblower Reform
Since its inception in 2006, the IRS whistleblower program has proved to be a valuable tool for identifying traditional tax cheats and corporate non-compliers. To date, awards from this program have totaled over $1 billion, and enforcement through whistleblowers has closed the tax gap by over $6 billion. While it is not without its flaws, reforms such as imposing interest on delayed awards and eliminating budget sequestration effects could greatly bolster its efficacy.
Interestingly, government programs that offer substantial contracts to entities capable of breaking the anonymity of certain cryptocurrencies have seen success. For example, blockchain analysis company Chainalysis was awarded a contract by the Treasury to de-anonymize the Monero cryptocurrency.
The advent of AI has opened the door to a two-sided coin for tax evasion. As it serves as a tool for tax evaders to structure tax shelters and evasive transactions, it can equally be used by whistleblowers to extract crypto platform data and cross-reference these with transaction records for public information.
Administrative Workability
While the unique challenges imposed by cryptocurrency— such as its anonymity and high energy consumption—suggest the need for intricate and advanced law enforcement, traditional tools might prove to be more effective.
Some of the proposed reforms like applying the wash sale rule to digital currencies and imposing an excise tax on digital asset mining could be difficult to pass and enforce. For instance, when considering the wash sale rule, it would involve distinctly identifying which among over 9,000 existing coins are “substantially identical” and fit the criteria – a task daunting and controversial enough to form its own tax policy discipline.
An alternative strategy, such as imposing a tax that directly targets the enormous electricity use in data centres rather than its superficial mining efforts could prove to be more effective. This would also cover the externalities to other operations at these centres, primarily the proliferation of AI applications.
No Revolutions Needed
Reining in tax evasion through crypto and factoring in the costs of mining doesn’t necessitate revolutionary new approaches to law enforcement; rather it simply means redirecting existing policies towards new targets.
The best way tax administrations can recoup lost revenue from taxable transactions is by capitalizing on the knowledge of the parties involved in these transactions. By incentivizing these parties and the exchange itself to ensure tax compliance, we can form a strategy that is both sustainable and effective.
Though attempts to impose stricter punishments for non-compliance have been proposed, offering substantial incentives and whistleblower reforms has been observed to be a more compelling approach to addressing this issue.
Columnist Andrew Leahey would argue that boosting enforcement of such existing policies is the most effective route to combating crypto tax evasion. For further readings on his insights, explore Technically Speaking.