There has been much discussion about how to reform the United States tax system to better serve the American people and it is time we move toward innovative solutions.
I propose a blockchain-based digital asset to bring a broken US tax administration system into the 21st century. A blockchain is simply an immutable decentralized ledger viewable by any computer or server on the earth.
We have a problem. The IRS has millions of filed tax returns going back two years it cannot process; it is delinquent in processing payments; this centralized agency, despite its size, has reached a level of inefficiency that renders them, in many cases, unable to even effectively collect taxes. There is only one word to describe the situation: broken.
Could the blockchain provide a solution to the high administrative and compliance costs of the IRS and its inefficiencies? Implementing a blockchain platform would provide the opportunity to digitize and automate tax processes, increase the trustworthiness of and transparency of tax-related transactions and reduce costs and other inefficiencies in the tax administration process.
Artificial specialized tokens would be developed that run on the same blockchain as the tax system. The tokens would serve not only as a mode or means of payment of tax and a store of value of a tax liability. They will also serve as a unit of account that would make payments traceable and immutable. The use of artificial, specialized tax tokens would assist in ensuring that the transactions that are recorded on the blockchain actually took place.
The increased traceability of payments using the blockchain would allow all stakeholders, the government and taxpayers, to monitor payments by making transactions more transparent. The data could directly flow into the taxpayer’s online blockchain based ledger. Taxpayers would then have one source to store and analyze transactional data for tax reporting purposes.
Blockchain has the ability to automate a number of aspects of tax administration. This would include data and information between parties and pre-populating tax returns with certain data. We may then be able to move to real-time automated assessment and collection of taxes.
A currency based on blockchain tokens could potentially automate many tax calculations and collect taxes on a real-time basis. A digital token could provide an important benefit for tax administration purposes. The blockchain would facilitate access to a relatively accurate data stream. This would be a major improvement over the present system which primarily relies on third parties and intermediaries as well as taxpayer payer self- reporting data to correctly assess tax liability.
Blockchain has the ability to allow for the future tokenization of assets, value or nearly any other component of our digital economy including tax returns. Tokenization converts the rights to an asset to a digital representation of that asset. Almost any physical or non-physical asset can be created.
As to determinants of the supply of the artificial specialized tax token, many types of tokens already exist which are suitable for tax administration purposes. A variation of stable coins such as tether may be suitable. These tokens would facilitate transparent and efficient payments and should be as readily accepted by the public as fiat currency. The tokens can allow the IRS to eventually achieve real-time automation of payments through devices known as smart contracts. Smart contracts are just computer code; they can be audited and verified just like a CPA audits financial statements.
To support a token structure, a protocol needs to be established for a public blockchain infrastructure. Ethereum is the most popular platform in use among the blockchains. Ethereum has scaling issues involving clogged throughput and can be expensive in peak times. Algorand may be a better protocol choice. Although much smaller in size than ethereum, due the broadness of the user base- the entire body of taxpayers in the US, developers should be attracted to the platform. Algorand should be able to incorporate a digital identity system and the artificial specialized tax tokens and it is fully scalable to the size necessary for such an infrastructure. Algorand is the only protocol with sovereign contracts.
Smart contracts would be used because they would help automate complex processes. When the artificial specialized tax tokens are created, the use of smart contracts allows data to be digitally transferred , owned and stored on the blockchain. This executable code acts only if specific conditions within the blockchain are met. Smart contracts can automate trusted activity between taxpayers and the IRS such as authorizing information exchanges and payment transfers.
Unlike traditional means of digitizing assets, the blockchain based artificial tokens programmed as smart contracts would offer other benefits that otherwise could not be achieved in legacy systems.
The key stakeholders who benefit from the adoption of digital assets are taxpayers and the IRS, in a word – all of us. The most transformative benefits of the blockchain are the ability to create trust in tax transactions, increase transparency and improve operational efficiencies.
The most transformative stakeholder adoption incentive is the technology’s ability to use the consensus mechanism that relies on multiple unrelated parties to validate and add transactions without the presence of any central intermediary agent or any malicious agent – in particular the IRS with it’s history of abuses of taxpayers.
Payments become completely decentralized rather than going through the IRS Treasury. Blockchain instead with it’s distributed database and consensus mechanism facilitates electronic payment systems composed of two parties, taxpayers on the one hand and the IRS, both of who do not trust each other.
There is a strong stakeholder adoption incentive that the blockchain provides by increasing the transparency of transactions. A clear audit trail is created of all transactions on the blockchain. This allows for the greater traceability of transactions, and it is realistically possible that traceability will be instantaneous and in real time. Rather than laborious and costly audits that take months and sometimes years, many audits will be able to be completed in minutes.
The last stakeholder adoption incentive is increased operational efficiencies. The IRS is under severe budget constraints; taxpayers, particularly businesses, have to spend extensive time and resources to comply with the legacy tax administration system. The blockchain creates inexpensive efficient platforms leading to significant savings in costs and a more robust tax system.
One systematic risk or concern is data privacy and protection over tax matters. While blockchain offers visibility and transparency, tax matters must have absolute privacy and confidentiality. Sensitive taxpayer data must be protected. The blockchain through cryptographic security, distributed ledgers and consensus mechanism is secure, but it is not immune to attack.
A permissioned blockchain structure instead of a public blockchain structure, is a way to minimize data privacy risks. A private blockchain however relies on the honesty of participants to keep data private and is only as secure as the participants themselves.
At this time a major systematic risk is the lack of a consistent regulatory framework. The blockchain raises many novel questions that do not fit well within the current legal and regulatory framework. These questions or uncertainties range from the legal rights of token owners, basic blockchain applications and the legal implications of irreversible smart contracts.
Another systematic risk is that interoperability between blockchains is in its infancy. Transactions may be frictionless in an application on a given blockchain. But integration or interoperability across blockchains needs to be further developed to support a wide range of interoperability.
In conclusion what I propose to remedy the ills of the present legacy tax system is a decentralized application ( a D’app). Dapps will be the technological foundation of all free societies in the 21st century. The present tax system is in crisis and cannot be saved; the vision of this Dapp can save it.