Blockchain and Tax: How cryptocurrencies can invent a more efficient economy.
The financial revolution has begun. Blueprints for decentralised institutions are being drawn up, and certain securities are embracing the blockchain. In this article, I want to talk about how Tax will be more efficient if the economy was on a blockchain. This article is part of a series on blockchain and finance that is potentially going to be sponsored by SmartCash. (More on SmartCash at the end of this article)
I’m going to start off with an explanation of what Tax is. I’m then going to describe Smart Contracts and Block Rewards on the blockchain. I’ll conclude with how Smart Contracts will make Tax more efficient and the benefits that this will bring to society. I’ll also talk about how an economy can do away with tax altogether through the use of Block Rewards.
Tax is a non-negotiable payment that is imposed on the public by a governmental organisation. Tax is used to pay for national needs and government functions.
The concept of tax is fairly easy to understand, but the application of tax systems and the rates the public have to pay can get extremely complicated. Some accountants have dedicated their lives to helping others calculate their tax. Failure to pay the correct amount of tax is met with harsh penalties, and the tax calculation is a source of stress for many households. If our entire economy was placed on the blockchain, all taxes could be automatically paid. This would save the public time, reduce the frictional cost to the government of collecting tax and allow those accountants to do other productive tasks. Smart Contract and Block Rewards can help achieve this win-win scenario.
A Smart Contract is a program containing a set of rules that aid transactions. Let me give an example:
Marginal Income Tax:
If Salary < $500
Then tax to be paid = 0
Else If Salary > $500 && Salary < $1000
Then tax to be paid = Salary * 10%
Else If Salary > $1000
Then tax to be paid = 100 + (Salary — $1000) * 15%
Send: (Salary — Tax) to Employee’s address
Send: (Tax) to Government’s address
Smart Contracts can act as filters between all transactions that occur in an economy. Bitcoin simply requires a sender’s address, a receiver’s address and an amount. A simple test is done to insure that the sender has more than the amount and then the transaction is executed by increasing the receiver address and decreasing the sender address by the specified amount. Other blockchains can host Smart Contracts and take on more input data and implement more complex logic. For our economy blockchain we can request a reason input field that will determine what Smart Contract to execute.
Possible Reasons:
Salary — Filter with Marginal Income Tax Smart Contract
Goods or Service — Filter with a VAT Smart Contract
Donation — Filter with Zero Tax Smart Contract
Asset Disposal — Filter with a Capital Gains Tax Smart Contract
These are just a few possible reasons, and there are many more that the system would need to cater for. Let me illustrate this point with a few diagrams.
In our current economy, some transactions already include tax. Sometimes you will receive your salary with a tax deduction already made and when you purchase an item, it sometimes includes the Value Added Tax (Sales Tax). However, many transactions occur without taking tax into account. It is then the responsibility of each individual and company to calculate how much tax they need to pay. Also the transactions that do include a tax component don’t always get it right, and tax rebates need to be made. This requires the government to pay for large and expensive organisations to police the system.
Smart Contracts can have a set of rules that not only look at the transaction details but could also look at the details of the sender and receiver. We might want a rule that says people over the age of 60 pay less tax. A Smart Contract could implement this.
Of course, we must not be naive about the nature of people. We must anticipate potential abuse and set up safeguards to prevent them. For example, an employer might abuse the system by paying his employees with a transaction that has a reason field of donation. By not paying tax, the employer can pay her employees more and give her company an unfair advantage. One possible way to prevent such abuse is to write additional rules into the donation Smart Contract filter. The Smart Contract can count the number of donations being made from one address to another and the time in-between. If the sender address has others transactions that resemble that of a company except for the fact that it’s making a series of monthly donations instead of monthly salaries, then the donation Smart Contract can freeze the amount in the transaction and notify the authorities to investigate further.
A transparent blockchain can allow for payment patterns to be compared and attempts to evade tax can be caught, and penalties applied. Machine learning techniques are sophisticated enough to be able to perform these checks. Abnormal transaction patterns can be flagged and inspected by authorities.
So how does this benefit society? An automatic tax payment system that quickly catches abusers has many benefits. For one, the government will collect more tax as fewer people will evade. Two, the government will have lower expenses in collecting tax as it won’t have to employ as many tax collectors. Three, this means society will enjoy better services if the government spends the taxes properly. Also, if a government official is attempting to misallocate tax funds then they will be caught by the public as all transactions on the blockchain will be transparent. And finally, four, if the government is spending less on collecting tax, they can afford to lower the tax rate which according to some economists will boost the economic growth.
So how does SmartCash fit in with all of this? SmartCash doesn’t have Smart Contracts on their blockchain, but they do have something else that could revolutionize the concept of tax. Block Rewards. Your traditional Bitcoin allocates all of the block rewards to the miners for keeping the integrity of the network with their machines. However, they are not the only party required to make a coin successful. Developers, promoters, investors, etc. are other parties that contribute to a coin’s success. Why don’t they get any of the block rewards? Well with SmartCash they potentially do. 70% of the block reward gets sent to a wallet where the community votes on how it is spent. With SmartCash there is no need for tax as the block rewards fund the governance operations. Block Rewards are the creation of new cryptocoins as determined by the algorithm specified in the genesis block. With some currencies, it is the only way new coins can be created.
In the future, we could see a country’s economy on the blockchain, and instead of having a set of tax rules, they could merely tweak the blockchain algorithm (at the beginning with the genesis block) so that x% of the block rewards go to the government’s wallet. In this future the cryptocurrency is decentralized, but the government is alright with this as they receive the lion’s share of the block rewards to meet the needs of society.
Although, this new system does have its drawbacks. When new coins enter the system via block rewards, we get a sort of monetary inflation. Inflation depreciates the value of the coin and is something that affects all coins equally. This means the rich and the poor will see their wealth decrease at the same rate, whereas a traditional tax system can apply higher rates to the rich. The second drawback is that the government loses its flexibility to change the system. Conventional tax systems give the government the power to raise more tax to meet shortfalls but this new system would require the government to be more disciplined with how they spend their budget as they cannot collect more. So we don’t want x% to be so high that inflation kills the economy and we don’t want x% to be so low that the government cannot afford to operate.
What I find exciting is that blockchains will not only revolutionize finance and disrupt the banks, but it will revolutionize politics and disrupt governments.
If you would like to learn more about SmartCash please visit: https://smartcash.cc/
You may also be interested in my other posts:
2. Blockchain and Foreign Markets: How international barriers have been broken down.
3. Blockchain and Catastrophe Bonds: How granulation can open up this new asset class.
If you have any questions or comments please let me know down below.
