Cryptocurrency Taxation: Looking for Light at the End of the Tunnel

Imagine if every time you bought a sandwich for a few dollars, the IRS forced you to treat as capital gains or losses any change in value of those dollars on the foreign exchange market since the time you earned them. It would be almost prohibitively burdensome: not only would you have to keep track of the dollar’s value on the open market, but you would have to track when specific dollars entered and left your bank account. Sounds ridiculous, doesn’t it? But that’s the way the U.S. government treats two legitimate forms of currency that appeal to people interested in sound money: gold and cryptocurrencies.

Movements to treat gold as legal tender for taxation purposes — that is, to exempt it from taxation — have had some success at the state level, but the issue has largely remained an elephant in the room for cryptocurrencies such as Bitcoin. Internationally, we have seen a few glimmers of hope: Australia has passed a law officially ending taxation of cryptocurrencies as property next year, and Ukraine is working on a similar law.

If one thinks about “the government” as a monolithic entity protecting its overall interests, it is hard to see why countries would ever change this rule, as it would facilitate a move away from fiat currencies, which give governments some of their power. However, I see a few paths for changing these harmful taxation rules.

First, competition among countries. By changing the way cryptocurrencies are taxed, Australia gets to be ahead of the curve in embracing a new technology, potentially benefiting its economy and rate of innovation. We’ll see whether other nations follow Ukraine’s lead in trying to break away from the pack in fostering the growth of cryptocurrencies.

Second, there is political pressure. If enough people demand change, some politician will stand to benefit from at least advocating the change. This institute proudly counts itself among the voices for change in taxation policies on gold, but the issue unfortunately hasn’t reached prominence in the national conversation to the point that the average American understands the rule or what is at stake. If beliefs about cryptocurrencies can somehow reach critical mass, the outcome might be different.

Third, there is the logistical nightmare of actually enforcing rules such as those currently in place at the IRS. If cryptocurrencies were more widely used, it would be prohibitively time-consuming and expensive for the IRS to audit even a small portion of largely anonymous Bitcoin transactions.

The irony of this debate is that most people who currently hold bitcoin and other cryptocurrencies are treating them exactly as the IRS is currently taxing them: as capital assets they expect to appreciate in value. However, this appreciation won’t continue unless the assets eventually have some use as commonly accepted currencies. AIER will continue to talk about this problem as it applies to both precious metals and cryptocurrencies. Let’s hope many others will add their voices.

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Max Gulker, PhD

Max Gulker joined AIER in 2015. His primary research areas are applied microeconomics and industrial organization. Max previously worked as an economist for Keystone Strategy, supporting expert testimony for antitrust and intellectual property litigation in high tech industries. Prior to that, he worked on financial litigation matters with NERA Economic Consulting. Max holds a PhD in economics from Stanford University and a BA in economics from the University of Michigan. Follow @maxgAIER.