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Blockchain Use Case for Taxes

Key Takeaway: Blockchain can reduce tax fraud and administrative costs. This technology has the power to provide insights that could be used to improve economic policies, tax data analytics, and federal, state, and local budget planning.

Blockchain technology may soon be used to help solve major global issues such as commerce, identity, democracy, and more. A recent survey by the World Economic Forum, for example, found that 73% of the 800 individuals polled fully expect blockchain to be used for tax collection purposes by government agencies by at least 2023. Automated tax collection via blockchain would help to secure indirect chains of custody, thus making the process more efficient and open.

For most physical and digital transactions, there is an obligation on the part of the buyer to pay taxes on purchases and an obligation for the seller to subsequently collect that tax and send it to the proper authority. The seller, in such cases, are hamstringed by complex tax regulations and requirements that often result in unforeseen costs due to accidental noncompliance. The government, on the other hand, must spend exorbitant amounts on administering the collection of taxes, dispensing tax returns, and managing tax regulations. They must also spend time and money fighting an increasingly losing battle against fraud and errors that result in unremitted taxes. This is an issue that faces governments from across the globe – from the first world to the third world.

Here are a few tax-based use cases that address these issues:

#1: Automate income and sales tax collection

A blockchain could be used to issue a national digital currency. This digital currency would be issued by a central bank, backed by the federal government, and connected to the nation’s traditional currency. This digital currency would be subject to government oversight and control by the central bank in much the same manner as fiat currency. This tax blockchain could simplify the collection process by ensuring the appropriate tax rates and rules are applied to transactions using validated, monitored interactions and trusted sources of calculation services, like a designated government agency or contracted third-party vendor. Such a use case would help eliminate the lag time that exists between when funds are collected and when they are remitted to the proper tax authority. This would also reduce the ability for rogue actors to collect and improperly use tax-based funds.

#2: Combat tax leaks and fraud

Tax leaks and fraud are a growing concern for nearly every government across the world, reducing funds needed for infrastructure projects, defense, research, and the public good. So just how big of a problem is this? The European Union alone, according to the European Commission, records loses of about 170 billion euros per year from tax fraud – most notably in the form of carousel fraud. Carousel fraud typically involves a closed group “selling” goods to each other without any physical transactions taking place. Each entity in each successive “sale” is responsible for paying the Value Added Tax (VAT). This tax, however, usually goes unpaid. The last entity in the chain then claims a VAT refund while the first entity “goes missing.” This type of fraud is typically very hard to detect, making it unlikely that perpetrators are caught and brought to justice.

Some organizations, such as the Organization for Economic Co-Operation and Development (OECD), have tried to solve issues like this via a shared tax information exchange, but it lacks legal standing and implementation is often seen as a significant regulatory burden on financial and government institutions.  A permissioned blockchain, a variant of traditional blockchains, could be used to address carousel fraud and other similar forms of fraud. For example, a tax officer or registered business with a valid VAT number could be given access to a blockchain-based system to log all commerce related transactions. The ledger could then be validated by a limited consensus process.

Since permissioned blockchain technology allows ledgers to have multiple users and to control who can do what, taxpayers could also use such a system. Taxpayers would be given a subset of permissions compared to government tax officials, most notably allowing them to record cross-border transactions. All transactions are instantly reflected in a distributed ledger, can be cross-referenced at any time by regulatory groups and law enforcement agencies, and the records cannot be tampered with – significantly reducing fraudulent tax return and refund claims.

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