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Consider a nation whose money is entirely digital (like Bitcoin), but centralized (unlike Bitcoin). Furthermore, the total money supply is fixed, i.e. money cannot be created nor destroyed. To be clear, not even the government can create or destroy money. Money can only be transferred between individuals, businesses and government. In a nutshell, this represents the entire monetary system. At any given point in time, the amount of money owned by an individual or a business divided by the total money supply represents their share of purchasing power at that particular point in time.

That’s pretty straightforward, but the tax system is where it gets weird. It involves none of the taxes we are accustomed to (e.g. income taxes, payroll taxes, consumption taxes, property taxes, capital gains taxes, inheritance taxes, etc.) All taxes are replaced with a single tax: a flat tax on the amount of money owned. This tax would be automatically levied at a pre-determined frequency (e.g. every month). For example, through a democratic process, let’s say that we agree that the we should be taxed at 36% annually. Then, every month, every individual and every business would be taxed at a flat rate of 3% of the amount of money they owned. This flat tax could be made arbitrarily progressive if part of it is used to provide a UBI. Of course, how that money is spent by the government would be decided, again, through a democratic process. Also, in reality, this tax would be levied by the different levels of government (e.g. federal, state and local). This has implications, but I won’t go over them here for the sake of brevity.

Unlike our current taxes, this tax fits perfectly with Adam Smith’s four criteria of good taxes (Theories of taxation):

“They are (1) proportionate to incomes or ability to pay, (2) certain rather than arbitrary, (3) payable at times and in ways convenient to the taxpayers and (4) cheap to administer and collect.”

Only the third criterion is debatable, but I think it would be as convenient as a tax can be. At least, you wouldn’t have to hire someone or spend hours to complete your tax return. On top of that, here are some obvious advantages of this tax system:

  • It eliminates all problems associated with physical money (e.g. unwanted destruction, wearing and counterfeiting)
  • It eliminates all possibilities of tax avoidance and tax evasion, and hopefully all the IQ points that go into those activities can shift towards something more valuable
  • It eliminates the power to create and destroy money from government, so no more hidden taxes in the form of inflation
  • It eliminates the power to create and destroy money from commercial banks, which is a major source of economic instability (e.g. bank runs simply can’t occur under this system)
  • It makes it easier to track the economic state of the nation (e.g. for issues like income distribution)

That said, it fundamentally changes the nature of money, which is a legitimate concern. Currently, money can be used as a pseudo store of value (“pseudo” because inflation slowly decreases its value over time). In this alternative system, the value of money would probably increase over time (because its fixed supply would almost certainly caused slow deflation). However, money could not be used as a store of value since the same earned money would be taxed over and over (and that wouldn't make up for the deflation). Thus, in order to save, money would have to be invested in a physical or financial asset that can be redeemed for money at a later time and/or that slowly pays dividends. This would require significant human adaptation on how we conceptualize money. In order for this system to work, it’s crucial that this digital money reflects purchasing power. Perhaps, human beings would simply reject the idea of that money as having any value and would immediately move towards another form of money. It’s hard to image how it would play out in real life.

My questions are:

  1. Has that type of taxation ever been considered in the economic field devoted to the study of taxation? If so, can you point me to it?
  2. How would this actually play out? (in your opinion, or according to the economic literature)
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    $\begingroup$ Money and wealth are not the same thing at all: reflect on how that affects Smith's first criterion. Monetary policy is a crucial tool for policy makers to create a stable, balanced, prosperous economy: reflect on how that would be affected by your scheme. When you've understood those, perhaps you'd like to answer your own question? $\endgroup$ – EnergyNumbers Jan 13 at 6:41
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Would this alternative monetary and tax system work?

Although in a non-digital context, what you propose resembles a wealth tax, which has been abolished in several countries (the Yellow Vests in France are pushing to restore that barbarism, though).

Inflation and changes in purchase power can still occur in the system you devise because keeping currency at a constant level does not guarantee that supply and/or utility will remain constant.

Consider a scenario where laziness becomes a trend and people decide to stop showing up at work. That trend would exacerbate the scarcity of goods and services, which ultimately will be reflected in systemic bottlenecks and in the government's failure to fulfill its obligations and responsibilities. BTW, some of those bottlenecks are likely to hinder the government's efforts against tax evasion and its ability to track the economic state of the nation reliably.

Furthermore, the implementation of digital currencies itself poses another disruptive factor in the "overall tracking of money: the loss of digital currency due to the owner's inability (whether factual or falsely alleged) to recover the private key of his bitcoins. That entails an evident risk of tax evasion, even if only for the prospect that the next democratic process will result in a lower tax rate.

Without a doubt, holders of digital currency will try to move their money out to foreign economies where tax policies are more favorable.

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  • $\begingroup$ I can't reply to your comment, EnergyNumbers, and I can't reply to your answer, Iñaki Viggers, because I don't have enough reputation. This seems like a flaw of the system to me, but anyway, I'll just reply here. I'll start with your answer, Iñaki Viggers. First, it's completely wrong to say that what I propose resembles a wealth tax. As EnergyNumbers pointed out, money and wealth are not the same thing at all. Under my system, there would be no taxes on real wealth (land, properties, financial assets, and so on). In a way, it's less of a wealth tax than any current tax system that inc $\endgroup$ – Félix Poulin-Bélanger Jan 13 at 20:21
  • $\begingroup$ (1) It resembles a wealth tax insofar as this taxation is caused by holding currency, as opposed to earning it (income tax) or spending it (sales tax). I do not dispute that wealth and money are not the same thing. (2)Tax rate may be constant, but purchase power (and gov. revenues) remain vulnerable to laziness and other factors that restrain the supply of goods and services. (3)To avoid counterfeiting, the implementation of digital currencies necessarily involve public-key cryptography. A person could falsely allege he lost his private key(s) so as to protect his money from being taxed. $\endgroup$ – Iñaki Viggers Jan 13 at 20:59
  • $\begingroup$ "This seems like a flaw of the system to me" One can always comment under their own question. Of course you should use the same account you posted the question with, not a different one. $\endgroup$ – Giskard Jan 14 at 8:55

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