Crypto assets that can be used as instruments of payment have proliferated into more than 10,000 variants since the 2009 debut of Bitcoin, the first and still the largest. The bewildering speed with which they have developed and the pseudonymity they can provide have left tax systems playing catch up.
In a new paper, we discuss how governments can address the emerging challenges of taxing these crypto assets while its use is still limited so that they prevent a leakage in tax revenue and protect the integrity of the tax system.
Classifying crypto
Views of crypto assets are diverse and held with passion. The prospect of liberating financial transactions from oversight by governments and the involvement of financial institutions is a libertarian dream for some. El Salvador and the Central African Republic have gone so far as to adopt Bitcoin as legal tender.
Critics, however, see crypto assets as not merely inherently worthless but a front for crime, scams, and gambling. They also point to their dizzying volatility. Bitcoin, for instance, soared from $200 a decade ago to nearly $70,000 in 2021 before plunging to around $29,000 today.
The collapse of FTX last year and recent US Securities and Exchange Commission lawsuits against Binance and Coinbase have fed anxiety among users while the appeal to criminal activities has been reflected in high-profile seizures of billions of dollars. These developments have triggered increasing scrutiny from policymakers and widespread calls for regulation.
But whether crypto assets ultimately boom or bust, a coherent way to tax them is needed.
A key issue is how to classify crypto assets—should they be regarded as property or currency? When crypto is sold for profit, capital gains should be taxed as they would be on other assets. And purchases made with crypto should be subject to the same sales or value-added taxes, or VAT, that would be applied for cash transactions.
So, one important task is to ensure application of these principles, which requires clarity on how to characterise crypto for tax purposes: in essence, as currencies for VAT and sales taxes and as assets for income tax purposes. While this is not easy due to the evolving nature of crypto asset transactions, it is perfectly possible. The deepest challenges are then in enforcement.
Revenue considerations
Crude estimates suggest that a 20% tax on capital gains from crypto would have raised about $100 billion worldwide amid soaring prices in 2021. That is about 4% of global corporate income tax revenues, or 0.4% of total tax collection.
But with total crypto market capitalisation down 63% from the late-2021 peak, tax revenues would then have shriveled. If these losses were fully offset against other taxes, there would be a corresponding reduction in revenue. In more normal times and with the current market size, global crypto tax revenues would probably average less than $25 billion a year. That, in the broader scheme of things, is not a huge amount.
There are also important fairness issues at stake. Though their pseudonymity makes it hard to be sure exactly who holds crypto, there are signs that ownership is heavily concentrated among the relatively wealthy—even though holding of crypto is strikingly common across people with low incomes too. Available surveys indicate that about 10,000 people hold one quarter of all Bitcoin.
There is also VAT. Crypto transactions have similarities to those in cash in their potential for being hidden from tax administrations. Today, the share of purchases made with crypto is still small. But widespread use, if tax systems were not prepared, could someday mean widespread evasion of VAT and sales taxes, leading to materially lower government revenues. This may be the biggest threat from crypto.
Addressing implementation
The most fundamental difficulty in taxing crypto assets is that they are “pseudonymous.” That is, transactions use public addresses that are extremely difficult to link with individuals or firms. This can make tax evasion easier. Implementation is thus at the heart of the matter for tax authorities.
The problem is surmountable when people transact through centralised exchanges, since these can be made subject to standard “know your customer” tracking rules, and possibly withholding taxes. Many countries are putting such rules in place with the expectation that tax compliance will improve.
However, reporting obligations could induce people to keep tax authorities ignorant by instead using centralised exchanges abroad. To address that concern, the Organisation for Economic Co-operation and Development has developed a framework for crypto-related exchange of information between countries. Implementation, however, is some way off.
A more troubling possibility is that reporting rules (and the failures of some crypto intermediaries) could induce people to transact increasingly through decentralised exchanges or directly through peer-to-peer trades where no central governing body oversees these transactions. Those are still extremely difficult for tax administrators to penetrate.
Given the complexity of the fundamental challenges posed by pseudonymity, the rapidity of innovation, the vast information gaps, and the uncertainties ahead, the tide has not yet turned in the battle to incorporate crypto properly into the wider tax system. Some of the elements needed for doing so—such as clarity in their classification for tax purposes—are clear.
But the challenges are fundamental, and the risks, particularly to the VAT and sales taxes, may be greater than people recognise. As many (though far from all) governments are beginning to realise, policymakers need to develop clear, coherent, and effective frameworks for taxing crypto.
Katherine Baer
Ms. Baer is chief of the Revenue Administration Division II in the IMF’s Fiscal Affairs Department, which provides technical assistance in tax and customs administration to more than 80 IMF member countries in the Western Hemisphere and Sub-Saharan Africa. The division also oversees technical assistance provided out of seven IMF Regional Technical Assistance Centers. During her career at the IMF she has also helped design and implement tax and customs reforms in Asia, Europe, and the former Soviet Union, including in crisis countries.
Ruud De Mooij
Ruud De Mooij is an advisor in the International Monetary Fund’s Fiscal Affairs Department, where he previously headed the Tax Policy Division. He has extensive experience in providing capacity development on tax policy issues in over 25 countries. Before joining the International Monetary Fund, De Mooij was a Professor of Public Economics at Erasmus University in Rotterdam, the Netherlands. He has published extensively on tax issues, including in the American Economic Review and the Journal of Public Economics. De Mooij is also a research fellow at the University of Oxford, the University of Bergen, ZEW in Mannheim, and member of the CESifo network in Munich.
Shafik Hebous
Shafik Hebous is a deputy division chief in the IMF’s Fiscal Affairs Department. He has provided extensive tax policy advice in advanced, emerging-market, and low-income economies. Shafik’s research covers a range of tax and fiscal policy issues and has been published in academic journals, including in the American Economic Journal: Economic Policy, Journal of Public Economics, and Journal of Monetary Economics.
Michael Keen
Michael Keen is deputy director of the IMF’s Fiscal Affairs Department. Before joining the IMF, he was professor of Economics at the University of Essex and visiting professor at Kyoto University. He was awarded the CESifo-IIPF Musgrave prize in 2010, and is an honorary president of the International Institute of Public Finance.
