The Bitcoin transactions tax

by
Dean Baker
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from Dean Baker

Like most economists, I have always been a Bitcoin skeptic. The question has always been what purpose does it serve?

The idea that it would be a useful alternative currency is laughable on its face. How can you have a currency that wildly fluctuates year to year and even hour to hour?  Imagine if you had a wage or rent contract written in Bitcoin. Both your pay and your rent would have more than tripled over the last year, likely leaving you unemployed and unable to pay your unaffordable rent. Economists often exaggerate the problem of inflation, but having currency that has large and unpredictable increases and decreases in value is a real problem.

So, Bitcoin may not be very useful as a currency, but maybe we can just treat as an outlet for harmless speculation, like baseball cards or non-fungible tokens. Well, it turns out that Bitcoin is not entirely useless. It is the currency of choice for those engaging in illegal activities like dealing drugs and gun-running, and of course extorting companies with ransomware. (Its value for this purpose took a major hit when the FBI was able to retrieve much of the money paid by Colonial Pipeline to the hackers who infiltrated its system. Apparently, Bitcoin transactions are not as untraceable as advertised.)

But Bitcoin cannot be dismissed as just fun and illegal games, it turns out it is also a major contributor to global warming. Bitcoin mining, the process by which new bitcoins are brought into existence, uses up an enormous amount of electricity. According to an analysis by researchers at Cambridge, Bitcoin mining uses more energy in a year than the country of Argentina.

This means that a lot of greenhouse gases are being emitted for essentially nothing. Most greenhouse gas (GHG) emissions are due to things like heating and cooling our homes, transporting our food and our ourselves, and also producing our food. These are all real needs. We can find ways to emit less GHG, for example by traveling less or switching to an electric car that hopefully be fueled by clean energy, but these involve some sacrifice and/or some expense.

Doing with less Bitcoin should be easy by comparison. That is the logic of taxing Bitcoin transactions; we tax the items for which we want to see less.

The Benefits of the Tax

First and foremost, a tax on Bitcoin transactions would raise revenue. I would propose a substantial tax on transactions of 1.0 percent annually. This compares to the tax 0.1 percent on stock trades that has been put forward by Representative Peter DeFazio in the House and Senator Brian Schatz in the Senate.[1]

The reason for suggesting a higher tax on Bitcoin, is that there would be little consequence for the economy if the Bitcoin market were seriously disrupted. People engaged in ransomware attacks might see somewhat more volatility in the value of their payments, and may find it slightly more difficult to change them back into traditional currencies, but otherwise there would be little economic impact.

By contrast, even with all the speculative trading on financial markets, they do still serve a productive purpose, so we would want to be cautious about imposing a tax that could be destabilizing. As it is, a tax of 1.0 percent is hardly without precedent. The United Kingdom currently has a tax of 0.5 percent on stock trades. It had been 1.0 percent until 1986. Nonetheless, the UK had one of the largest stock exchanges in the world.

Clearly a 1.0 percent transactions tax on Bitcoin will not shut down the market. However, it will substantially reduce the volume of transactions. It also is likely to make the currency less attractive to anyone who doesn’t need it for illicit purposes, which will reduce its value. This should mean that people will devote fewer resources to mining Bitcoin, which is a real win for the world.

There is also the issue of how much revenue a Bitcoin tax would raise. Currently, trading volume is around $1 billion a day or $350 billion a year. A tax of 1.0 percent would get us $3.5 billion a year, if there were no decline in trading volume. But, of course, the whole point of the tax is to reduce trading volume and interest in Bitcoin. If we see volume cut in half, due to both less trading and a lower Bitcoin price, then we would raise $1.75 billion a year or $17.5 billion over the course of a ten-year budget horizon.

This is not huge money in terms of the whole budget. CEPR’s “It’s the Budget, Stupid” budget calculator tells us that is would be equal 0.03 percent of the total budget. That’s not a huge deal, but not altogether trivial. The annual take is equal to roughly 110,000 food stamp person years.

But there is another benefit of going the Bitcoin transaction tax route. We can experiment with enforcement mechanisms with little downside risk.

It is often claimed that financial transactions taxes are unenforceable. The evidence suggests otherwise. The UK raised an amount equal to 0.2 percent of GDP annually (roughly $44 billion in the U.S. economy) from its tax on stock trades. (Other financial assets are not subject to the tax.) There are many other countries in the world that raise substantial revenue from financial transactions tax.

We also have a modest financial transactions tax in the United States already. Stock trades are subject to a tax of 0.0042 percent. The tax raises roughly $500 million annually, which is supposed to finance the operation of the Securities and Exchange Commission.

Clearly financial transactions taxes are enforceable, but there are certainly many trades that escape taxation. Evasion is likely to be an even bigger problem with Bitcoin, where many of the transactions involve illegal activity.

This is why we have a great opportunity to innovate. In addition to the other mechanisms available for enforcement, we can also offer a reward to people turning in tax evaders. We can, for example, give them 20 percent of the tax collected from their lead.

To take an example, suppose someone trades $200 million in Bitcoin. With a 1.0 percent tax rate, they would owe $2 million. If they chose not to pay their taxes, and an employer reported this person to the I.R.S., they would stand to collect $400,000, which would be a pretty payday. This sort of reward system would give workers a strong incentive to report the tax evasion of their bosses.

A tax on Bitcoin transactions would be a great place to test run this sort of incentive. Since there is little reason to care if the Bitcoin market is disrupted, there is not really a downside. If the reward system proves effective in cracking down on evasion, we have a new tool that can be applied elsewhere if we choose to tax financial transactions. We also can see any problems that might appear in this system and make the necessary adjustments so that we are better prepared to implement a financial transactions tax to larger financial markets.

In short, the Bitcoin market gives a great laboratory for experimenting with financial transactions taxes. While there is enough experience both here and elsewhere in dealing with financial transactions taxes that we can be reasonably confident that a FTT can be implemented without great difficulty, until there is political will to put in place a broadly based FTT, we can use the Bitcoin market as a place to have a practice tax.    

[1] I have proposed a somewhat higher tax on stock trades of 0.2 percent.