International Monetary Fund (IMF) researchers published a working paper describing the challenges introduced in collecting taxes related to cryptocurrencies.
Specifically, the report highlights how, given that cryptocurrencies act as both investments and currencies, the appropriate tax treatment has become more complicated. It also explains how the pseudonymous nature of cryptocurrency systems makes collection and enforcement of the tax code more difficult.
The paper discusses how, in most cases, cryptocurrencies are treated as property for the purpose of income taxes. This means they generally have capital gains taxes — adding a significant administrative load for those who choose to transact using them, and requiring calculations for every transaction.
For value added taxes (VAT) and sales taxes, the IMF highlights how the pseudonymous nature can make collection difficult and therein the need for accurate records of when transactions occurred due to the volatility in prices. It also highlights how VAT can be applied to cryptocurrency miners to newly minted coins.
The paper also discusses the controversial proposition of taxing proof-of-work miners due to their environmental externalities, suggesting they are best targeted with a broad carbon tax, but does suggest more targeted taxes could be justified.
Tax evasion means billions lost, IMF predicts
The researchers also highlight how there is meaningful tax evasion in the cryptocurrency ecosystem, though they also note that given “the serious crimes that have been the primary focus of concern and investigation, however, tax evasion is likely a by-product rather than a primary motivation; indeed, the purpose of the extensive money laundering in cryptocurrency is to make illegal gains appear legal, and even perhaps consequently subject to some tax.”
Unfortunately, the paper is unlikely to provide an estimate on the scale of tax evasion, but it does attempt to provide estimates for the potential amount of revenue. Researchers attempt a couple techniques for “back-of-envelope” calculations and ultimately suggest that the potential revenue from improved taxation of cryptocurrency capital gains is somewhere between $10 billion and $323 billion, depending on the degree of volatility and amount of gain realized.
They also provide estimates for various transfer or payment taxes, including applying the tax applied to securities trading by the European Commission, which they estimate could come to around $15.8 billion, but assume all cryptocurrency transactions are treated as security transactions.
If all cryptocurrency transactions were instead taxed as VAT, they estimate the potential revenue to be between $47.4 billion and $118.5 billion, depending on how much could reasonably be collected.
Fundamentally, the authors point out that the largest issue is that pseudonymity and its use in crime make accurately identifying and collecting taxes from cryptocurrency ecosystem participants harder than other financial rails.
Luckily, the authors are able to highlight some good news for tax authorities and bad news for crypto ideologues. “Contrary to the vision of the original crypto designers—a core role has emerged for centralized institutions of various kinds in the transacting of crypto assets.” They suggest that these are a natural target for tax authorities to ensure that users are identified under know-your-customer (KYC) rules and can enable tax authorities to help collect taxes. In the US, they discuss how the Infrastructure Improvement and Jobs Act made it so a larger number of providers are expected to report details to the Internal Revenue Service (IRS) about customer transactions.
The report further suggests decentralized finance (DeFi) potentially enables evasion of these reporting requirements, which the IMF suggests could potentially be rectified by increasing the information that miners themselves are expected to report — a controversial suggestion in the cryptocurrency ecosystem that does face problems in terms of identifying and interfacing with these miners.
Finally, the authors highlight how well cryptocurrencies are pseudonymous; the ledgers are very often public, and eventually this information can be determined even if it’s not currently possible.
Previously, the IMF warned about the risks of nation-state adoption of bitcoin and other cryptocurrencies, but in this report discussing the adoption of cryptocurrencies for payments, it says “even the low figures in El Salvador are not unimpressive.”
Outside of taxes, the paper also highlights how increased usage of cryptocurrencies could potentially “undermine the tools of macroeconomic management” by reducing the influence of general monetary policy tools, which was among its many concerns previously with nations adopting cryptocurrencies.
This IMF work paper highlights the current difficulties for tax authorities in collecting tax revenues in a pseudonymous system and suggests that there is still significant interest in further de-anonymizing cryptocurrency.