TaxProf Blog

Editor: Paul L. Caron, Dean
Pepperdine University School of Law

Saturday, August 5, 2017

Weekly SSRN Tax Article Review And Roundup

This week, Sloan Speck (Colorado) reviews a new work by Manoj Viswanathan (UC-Hastings), Tax Compliance in a Decentralizing Economy.

Speck (2017)In a compelling new work, Manoj Viswanathan connects two seemingly disparate hot spots in taxation, the gig economy and blockchain-based cryptocurrencies, to argue that increasing economic decentralization presents a significant and underappreciated threat to tax compliance. For Viswanathan’s paper, decentralization essentially reflects the rise of direct peer-to-peer transactions through virtual means, rather than through institutional intermediaries. Companies such as Airbnb and Uber match sellers of lodging and transportation to buyers, while cryptocurrencies such as Bitcoin allow secure transfers of value without banks. Independently, the gig economy and cryptocurrencies present serious issues for tax administration. When combined, Viswanathan argues, individuals could buy and sell entirely outside of taxing authorities’ traditional purview, which would enable rampant noncompliance. For Viswanathan, the solution is enhanced information reporting rules to account for decentralization, including incentives to disclose one’s own identity in transactions.

Viswanathan begins by reviewing the role of centralized institutions in facilitating individuals’ accurate self-assessment through information reporting. These institutions act as market-makers or intermediaries for large volumes of transactions among large numbers of counterparties, and, as such, these institutions are well-positioned to relay information to taxing authorities. Viswanathan demonstrates that such information reporting is highly effective at encouraging tax compliance in both the domestic and international contexts. Decentralization could disrupt this status quo. For me, it is less that the literature on tax compliance has ignored the role of centralized institutions in information reporting than that scholars often cast reliance on such (often private) institutions as a feature, rather than a bug. Viswanathan has identified a genuine challenge to the regime of broad-based individual income taxation that developed during World War II, a sort of Y2K problem that could precipitate disaster if left unchecked. For this reason, Viswanathan advocates preemptive intervention.

The question remains, however, of whether the problem of decentralization will explode or fizzle as these technologies mature. A fizzle might render precautionary interventions moot (at best) or inadvertently harmful (at worst). For example, Viswanathan raises the specter of a blockchain-based derivatives market that operates anonymously and without any centralized oversight. Under this view, it’s a slippery slope from Silk Road to ersatz stock exchange. But this slippage has yet to occur (and may never occur), and prospective regulation may impair legitimate uses of blockchain technology. Similarly, Viswanathan alludes to the possibility that blockchain technology may substitute for depositary institutions, such as banks. Setting aside cryptocurrencies’ volatility, there remain questions of interest payments, insurance, and counterparties’ faith in the currency’s durability. The dollar is not easily displaced; even the utopian libertarians at the Porcupine Freedom Festival tend to denominate transactions in dollars. Furthermore, technological innovation may disrupt the disruptors. Self-driving cars raise tax issues different from those implicated by Uber and Lyft, and solving the latter will do little to aid in the former. If the future of the gig economy and cryptocurrencies is uncertain, reactive (or responsive) changes may prove superior to trying to get out in front of the problem.

Indeed, Viswanathan seems largely sympathetic to reactive changes in tax compliance rules as they apply to the gig economy, such as lowering information reporting thresholds and forcing specific market makers for peer-to-peer transactions to share tax-relevant data with Treasury. (Other potential tax levers could include more comprehensive rules for withholding and current payment of tax due, as well as incentives for second-party reporting, such as those under FIRPTA.) As Viswanathan recognizes, the gig economy is not fully decentralized, in that large institutional actors still exist. Cryptocurrencies pose a more difficult problem for tax administration, and Viswanathan proposes strict monitoring of the entry and exit points of blockchain systems, coupled with incentives for voluntary self-identification by cryptocurrency users who place limited value on anonymity. But if only blockchain enables “true” decentralization, then perhaps efforts to address cryptocurrencies should be separated conceptually from efforts to shore up compliance among gig economy workers. In this sense, decentralization may be multiple problems that demand completely different approaches.

Finally, some reflection on the values advanced by Viswanathan’s normative claims is warranted. Tax compliance in the face of decentralization may advance horizontal equity or rule of law considerations, or it may simply move our tax system closer to a comprehensive income tax base. Vertical equity and efficiency concerns, however, complicate these rationales. Viswanathan notes that the labor-oriented side of the gig economy (think Taskrabbit and Uber) involves individuals who typically earn around $20,000 per year, of which roughly one-quarter comes from the gig economy. Information reporting that increases these individuals’ tax burden may have adverse distributional consequences, absent adjustments to the rate structure. Also, if many individuals tap into the gig economy on a one-off or occasional basis, taxing these transactions may deter them completely. Even a low tax rate may force hobbyist knitters to take their scarves off of Etsy and box them up for grandchildren—far from an efficient outcome. If decentralization improves distributional outcomes and efficiency, these values should be weighed against any costs from decreased tax compliance.

Overall, Viswanathan’s work makes an important and valuable contribution to scholarship on the gig economy and cryptocurrencies, as well as larger literatures on tax compliance.

Here’s the rest of this week’s SSRN Tax Roundup:

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