Don't Tax Bitcoin Out of Existence

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Many people find cryptocurrencies such as Bitcoin appealing because they aren’t attached to any government and are thus immune to inflation associated with fiat money. But governments will inevitably play a role in what the future of cryptocurrencies looks like through taxation and regulation. Since governments naturally fear what they can’t control, it is important to keep abreast of these issues. I’m planning a series of blog posts on this topic, starting today with the basics of cryptocurrency taxation.

The IRS made a critical distinction between property and currency and decided that cryptocurrencies are property. The 2014 decision was applauded by many prominent members of the Bitcoin community, who stand to financially benefit from this classification. Bitcoin investors and miners (who operate Bitcoin’s blockchain ledger of transactions and get paid in new Bitcoins) are taxed at the 15 percent capital gains rate rather than much higher income tax rates. However, this enthusiasm is short-sighted.

Because the IRS considers cryptocurrencies property for taxation purposes, it views every retail transaction as a taxable event. Suppose you went to the store and bought a quart of milk with U.S. dollars. You would pay a sales tax at the time of purchase, and that would be it. Now suppose you and the retailer wanted to transact in Bitcoin. Under current rules, you would have to record the value of Bitcoin when you acquired it, record the value of Bitcoin when you exchanged it for milk, and recognize the change as a gain or loss. The IRS doesn’t enforce the rules, but if it did, it would render cryptocurrencies inappropriate for everyday use.

While these rules are difficult for the IRS to comprehensively enforce, authorities have begun taking a closer interest in Bitcoin. Last November, the IRS requested records of all Bitcoin transactions from Coinbase, the largest exchange in the United States, to look for tax evaders (Coinbase is still fighting the request). And the internet abounds with sites instructing users on the complex record keeping necessary to comply with current rules.

Anyone who hopes Bitcoin or other cryptocurrencies will become more than short-term speculative investments should support calls for changes to the current IRS position. Bitcoin miners and investors may be getting a sweet deal for the moment. But if Bitcoin never takes hold as an actual currency, all they’ll be left with is an asset that unlike gold or petroleum lacks any tangible value. Almost everyone agrees that mass adoption of cryptocurrencies will be slow, and speculative investments in BItcoin have certainly paid off in the short term. But if governments prevent it from ever being a viable currency, a bubble will eventually burst.

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Max Gulker

Max Gulker is an economist and writer who joined AIER in 2015. His research often focuses on free markets and technology, including blockchain and cryptocurrencies, the sharing economy, and internet commerce. He is a frequent speaker at industry conferences, especially on blockchain technology. Max’s research and writing also touch on other economic topics, including governance, competition, and small businesses.
 
Max holds a PhD in economics from Stanford University and a BA in economics from the University of Michigan. Prior to AIER, Max spent time in the private sector, consulting with large technology and financial firms on antitrust and other litigation. Follow @maxgAIER.