THE NEW MONETARY UNIVERSE AND ITS IMPACT ON TAXATION

by Richard Rahn

Novecon

 

Moving money at the speed of light to any place in the world anonymously over the Internet will soon be as easy as a few keystrokes on your business or home computer. Such anonymous monetary movements substantially increase the potential that the size of the identifiable tax base will be diminished. Government tax authorities are both challenged and threatened by this new technology. As expected, there are some at the Treasury and Justice Departments in the United States who are proposing regulations, essentially requiring every American business and individual to report every item of income or expenditure worldwide, through electronic means, to the government. Not even the Nazis or communists were able to achieve this level of proposed intrusiveness. Fortunately, many in the new Congress are set to oppose this latest attempt to deny us any remnant of financial privacy.

We are now at a crossroads. The new technologies are going to enable many American businesses and investors to pick up and leave--electronically. The more the government tries to tax, regulate, control and confiscate, the greater the incentive for business and investors to leave.

State of the Technology

Electronic transfers greatly reduce the cost of transaction and the possibility of loss. Americans are now starting to pay their bills by using credit cards, and by inexpensive "Smart Phones." These systems provide customers with a full record of income and payments: good for record-keeping, but bad for privacy. In fact, the IRS is already working on a system to gather all your financial information electronically and prepare your tax return for you. That might crimp the tax lawyers and accountants a bit, but the Big Brother police state aspects are at least as unpalatable.

There are, however, technological alternatives to blind submission to the state. Experiments are now under way. One is called "E-cash," operating in Amsterdam by a company named DigiCash. The electronic version of the anonymous paper dollar is now with us. Individuals will be able to move their funds around the world, literally at the speed of light, from one bank to another or to a creditor, without the bank knowing to whom the money was paid, or the creditor knowing from which bank or even country the money came.

Another experiment is the Mondex system in Swindon, England. Under this system, which has many of the same anonymous features of the DigiCash system, payments can also be made outside the banking system--directly from card to card (by smart card reader/writers).

Through the use of cryptographic technology (scrambled numbers for personal codes), the ease of conducting electronic transaction would be combined with the elegant anonymity of paying in cash. The two most important features of the "E-cash" system--security and anonymity--will be ensured by using cryptographic digital signatures to establish the authenticity of the payer, while at the same time assuring his anonymity and untraceability. The virtual electronic dollar bills will, at the same time, be assigned individual electronic serial numbers, which will also be checked for authenticity. The bank will know how much to pay and what code to pay it to, but will not know the owner of the receiving code, hence the payee too remains anonymous.

Naturally, the IRS doesn't like it. But the matter may be beyond its control. Soon, Americans will be offered two competing versions of the future. The first is the society in which all of your transactions can be monitored by the government (and other interested parties). The second is where you as an individual choose which of your transactions will be made available to curious eyes, and which will remain anonymous. Individuals do run the risk of not being able to prove they paid their bills under some of the anonymous systems.

The View of the Future

Many in the government and other organizations will argue for a ban on anonymous systems, contending that such capabilities benefit primarily drug traffickers, money launderers, assorted terrorists, and plain old tax dodgers. Libertarians, on the other hand, will warn of the dangers that accrue when government has almost total scrutiny of individuals. One doesn't have to envision what a Hitler or Stalin could have done with such a system; just try to imagine the kind of ordeal investigators could inflict on anyone trying to get Senate confirmation for government service.

The fact is that the fears of both sides are correct. But some of the legitimate fears of the government can be mollified by repealing the income tax and substituting low rate consumption and withholding taxes. While anonymous systems will make detection of criminal activity more difficult, especially as private encryption protocols are developed, current regulations to thwart money launderers and drug dealers are also failing. This fact does not justify imposing further restrictions on legitimate money transfers by honest citizens to the detriment of our civil liberties.

The revolution taking place in electronic money means that banks and other organizations will be able to create their own money for transactional and/or investment purposes and literally move these moneys around the globe at the speed of light. The definition of money as a government-created legal tender will become less and less relevant. The existing distinctions between money, goods, services and assets will increasingly disappear as they become more interchangeable. Unfortunately, some will misuse the new technology either with criminal intent or through irresponsibility, causing losses to users. Knowledgeable markets are likely to be a better antidote for wrongful actions than more government regulation.

Definitions of income and money will be increasingly blurred, presenting an impossible task to a tax collector who tries to tax things which can be transformed instantaneously into something else and moved to anywhere in the world with no paper or electronic trail. Public-key cryptography, which has already been developed, means electronic bank notes can be certified without the issuer knowing to whom it was issued. Smart cards used as an electronic purse can have the same anonymity as paper cash.

The electronic age, with virtually instantaneous international financial transactions and with encrypted confidential smart cards substituting for money, will make the taxation of capital transactions, interest and dividends increasingly problematic. In an age where most people can today transfer money and pay bills with an ordinary telephone, enforcing taxation on these types of transactions will become virtually impossible. The cost of trying to enforce them may well exceed the revenue collected and certainly will exact a price in terms of lost economic efficiency and lost privacy rights that exceeds the benefits of their continued taxation.

Government authorities cannot stop this revolution, because it is a worldwide revolution with too many people having the knowledge. Censorship and regulation will not work because progress in developing the means of evasion will always be far ahead of those who are trying to restrict it. In the same way that most totalitarian governments have largely given up trying to control the flow of information, because technology has made it an impossible task, governments will need to realize that the old central bank monopolies on the issuance of money will also go the way of the buggy whip.

Government officials have two choices: to redesign their tax and monetary systems to reflect technological reality, or to try to create a system in which every investment and every expenditure by every person is known throughout their lives. In the new world of monetary freedom there is no halfway ground. Either the government will know everything, or the government will only know what is voluntarily revealed. An all-knowing government is doomed to fail, practically and politically, and attempts to impose a “Big Brother” government could impoverish the nation and trample our liberties.

Will Tax Evasion Increase?

If taxpayers may easily avoid reporting particular types of income or transactions with virtually no danger of being caught because of technological innovations, then the tax on that type of income or transactions is, quite literally, voluntary, and will only be paid by those conscientious citizens who abide by our tax laws out of a sense of duty and honor rather than the threat of civil or criminal penalties.

The cybermoney revolution makes some forms of tax evasion very easy. Given that it will be increasingly possible to move monies around the world from computer to computer, and in and out of smart cards anonymously, without going through the banking system, as previously mentioned, tax evasion can be accomplished with a few strokes of the keyboard.

A few examples: Assume you are a lawyer in New York doing work for a client in a jurisdiction without an income tax. You do your work in New York but send it via the Internet (electronic mail). The client agrees to pay you in electronic money. As your bills become due, the client sends the money to you over the Internet and it is downloaded into your computer. You in turn pay your bills by sending electronic cash from your computer and by loading up your smart card. And only you--a smart New York lawyer--decide what electronic and paper records both to create and keep. Anyone who can sell their personal services over the Internet--lawyers, programmers, writers, architects, engineers, etc. will have the same ability. If tax rates are kept low enough, and taxes previously collected from individuals are instead collected at the business level, both incentive and opportunity to evade legitimate taxes will be reduced.

Tax evasion is normally considered a reprehensible crime, and the sanctions are serious for tax evaders in most jurisdictions. But what if the government is totally corrupt (which occasionally occurs with local governments in the United States)? In the United States, it is a crime to provide funds to a criminal organization. If you pay taxes to a governmental unit that is operating essentially as a criminal organization, are you not both violating the law and engaging in immoral behavior? What do you do about a government that is only partially corrupt? Provide only partial tax payments? What do you do when the government is not spending the tax money on a cost effective basis? For instance, assume there is a government program that provides food for the needy, and that there is a private charity that does the same thing for the same people in a less costly and more effective manner. Would not the moral person refuse to pay the government tax, but instead support the private charity to an equal or greater amount?

The point of the above discussion is that if it becomes increasingly easy to avoid taxation, will not many people, who are not criminals in the traditional sense, begin to make their own moral decisions about how much government to support.

Tax Enforcement and Potential Abuse

According to House Ways and Means Committee Chairman Bill Archer, approximately 44 million Americans had an incident with the IRS last year. Most often they received deficiency notices. It is well documented that most individuals and businesses pay the requested amount rather than fight the IRS, even though the IRS is very frequently wrong. Why? Because individuals and businesses find it less costly to pay the "bribe" to the IRS than to fight. Bribe is the appropriate word, because many IRS officials are expected to meet quotas (a.k.a. performance standards, or some other politically correct term). Hence, officials are more interested in collecting revenue than administering fairness. Taxpayers know that given the complexity of the tax laws and the cost of fighting the IRS, the deck is stacked in favor of the bureaucratic totalitarians. So, they pay protection money to avoid an even more costly audit or legal suit.

Most Americans were appalled when they learned the extent to which paid informants were used by the communists to "protect the state." Yet, increasingly in our own country the government relies on paid informants to report on the alleged tax, environmental or other misdeeds of businesspeople. Thus, the incentive is to make charges without sufficient evidence. Unfounded charges can easily destroy the reputation and financial well being of an individual or business. The difference between the action of the U.S. government and the former communist East German secret police is a matter of degree, not form.

Most Americans are not aware of the broad powers that the government already has to pry into and control their monetary affairs. Much of the recent regulation has been enacted as part of “the war on drugs” and a general attempt to control “money laundering.” The Treasury and other government departments have been holding meetings in an attempt to choose the nature and form of regulation that they will impose on what they refer to as “cyberpayments.” The goals of the proposed regulations range from the noble to the base. Reasons given for increasing regulation include: “The need for oversight of the soundness and safety of financial institutions”; consumer protection; law enforcement (drugs, etc.); and of course, taxation. The Financial Crimes Enforcement Network (FinCEN) of the Treasury Department has taken the lead in the effort, to date, to propose regulation of cyberpayments. FinCEN administers the Bank Secrecy Act (BSA) and implements policies to detect and prevent money laundering.

There are a number of advocates within the regulatory bureaucracy and policy staffs to merely extend the existing money laundering regulations and BSA provisions to nonfinancial businesses and individuals who engage in “cyberpayments.” To understand what this might mean, and the cost and loss of freedom it would entail, it is worth reviewing the present laws and regulations which now primarily affect financial institutions and their employees.

On September 23, 1994, President Clinton signed the Money Laundering Suppression Act of 1994 (“the Act”). This act increases the federal government's BSA oversight of money transmitting businesses that engage in check cashing, currency exchange, money order and traveler's check sales, and money transmitting and remittance services.

The BSA currently requires a person who transports, mails, or ships currency or other monetary instruments in amounts greater than $10,000 into or out of the United States, to complete United States Customs Service Form 4790, Report of International Transportation of Currency or Monetary Instruments (“CMIR”). The term “monetary instrument” is defined in the BSA as: (i) currency; (ii) traveler's checks in any form; (iii) negotiable instruments (i.e. personal checks, business checks, bank checks, cashier's checks, third party checks, promissory notes, money orders) that are either in bearer form, endorsed without restriction, made out to a fictitious payee or otherwise in a form that title thereto passes upon delivery; (iv) incomplete negotiable instruments signed but with the payee's name omitted; and (v) securities or stock in a bearer form.

Money transmitters, as defined in the Act, are businesses (other than the United States Postal Service, a securities broker/dealer or a bank subject to the BSA) that provide check cashing, currency exchange, money transmitting or remittance services, or that issue or redeem money orders, traveler's checks or other similar instruments.

Each money transmitting business registering under this provision must provide Treasury with:

1. the name and location of the business;

2. the name and address of each person who: (a) owns or controls the business; (b) is a director or officer of the business; or (c) participates in the affairs of the business;

3. the name and address of the depository institution(s) at which the business maintains a transaction account;

4. an estimate of the annual volume of business; and

5. any other information required by Treasury.

Failure to comply with the registration requirements could result in a civil money penalty of $5,000 a day for each violation, a criminal penalty of five years in prison and/or a fine ($250,000 for individuals or $500,000 for corporations) and civil forfeiture. To establish a criminal or civil structuring violation, the government no longer has to prove that the defendant knew structuring itself was illegal.

In addition to the above provisions the act also amends the BSA to:

expand the definition of a financial institution subject to the BSA to include casinos or gambling establishments with annual gaming revenues of more than $1 million which are: (i) state- licensed casinos; or (ii) Indian gaming operations under the Indian Gaming Regulatory Act.

Other provisions of the act:

If these and other provisions are extended to nonfinancial institutions and individuals, it is not overstatement to say that Americans will be required to spy on their friends and neighbors--thus the end of any sense of personal privacy and financial freedom.

Popular appeals to “wage war” on criminals and drug dealers, as an excuse for improper bureaucratic invasion of legitimate financial privacy, must be resisted. Criminal action can be curtailed without resorting to an invasive government, which history shows inevitably leads to abuse.

Conclusion

The danger is very real, but the battle for financial freedom is not yet lost. To win this battle, advocates of liberty will by necessity need to be involved with tax reform. The abolition of the income tax and its replacement with a low-rate noninvasive tax system will take away much of the rationale for income and expenditure monitoring by the government.

In the age of the cyberpayment, we cannot both keep the present income tax system and enforce it, and at the same time keep our liberty and privacy. Let us all work together to get rid of the income tax rather than ridding ourselves of liberty.

Prepared for the Cato Institute's 14th Annual Monetary Conference, May 23, 1996, Washington, D.C.