Introduction
Web3 and blockchain technology continues to cause disruption in many industries. This is welcome development - a technology revolution that guarantees transparency, immutability and other features lacking in web2. Taxation is a big issue almost in every sector. The system is a little different from country to country, but we see one issue or another no matter where you live.
Technology continues to evolve and attempts to solve old challenges. Blockchain technology is one of the components of web3 that has the potential to eliminate most challenges in the tax industry. This article will look at the solutions. But first, lets take a look at current issues hurting taxation today. Then we will see how web3 has some or all of the solutions.
Current challenges of taxation.
Below are some of the glaring challenges of the tax industry today. These are mostly general challenges, but all might not apply to your country or location.
1. Hiding income: This is the biggest issue with taxation and it exists virtually in every economy. Some bad citizens try to avoid paying tax through so many tricks. One commonest way is by reporting lower incomes for a business. That might involve falsification of sales receipts figures and manipulating figures to reflect a minimal inflow of funds into the business. Through this means, the overall income is significantly lower that it really is.
Some wealthy individuals evade tax by sending their earnings abroad or investing in oversees countries. This is so common among corrupt politicians in third-world countries. They usually steal public funds using their elevated political position. Then they are able to operate foreign bank accounts and hide such illicit funds in foreign accounts. In this way, they are able to evade tax and also steal from public funds.
2. Inefficient tax enforcement: Given the general disdain for paying taxes and the sophisticated means they employ to avoid tax, it is really a difficult thing to effectively perform tax administration. many tax officers lack sufficient training and technicalities to effectively do their jobs. Technology has made it easy to hide income or lower it. While many citizens are advanced users of technology tools and skilled in using them to make and hide income, tax officers are usually abandoned to their fate.
The issue of tax enforcement technical deficiency could be seen more in third world countries where technologies like blockchain and web3 enable users to make income and convert the funds through local financial services without any records for tax officers. And when tax officers do not even know if their is such as a thing as crypto trading, it becomes difficult for them to collect taxes effectively.
So poor funding and training of tax enforcement officers is a big reason
3. Black markets: The informal economy is another big challenge to tax administration. This comprises all economic activity that has no legal or business framework by the government. They are usually low level economic activities that still generate taxable revenue but are not taxed like small business, low level skilled workers, P2P networks, street vendors, etc.
This informal economic sector is usually not taxed because their business records is not recorded or stored in any government computer. Being informal, there is usually no receipts or official documentation for financial transactions. Most of them do not use any financial institutions like the bank to receive or save their income. As such, it becomes difficult to track their earnings and tax them. Unfortunately, the informal economy is a huge one and the government looses a lot of revenue that should have been collected from such individuals or businesses.
The above are some challenges of current tax systems. These challenges require a higher platform or technology to address these issues. Web3 is ready to tackle them and improve taxation as we can see in the next section.
How Web3 improves taxation
The main instrument of web3 to solve many of the taxation challenges above is blockchain technology. Tax administration is all about keeping accurate records and making payments. Interestingly, the blockchain is an excellent technology to store data in a transparent and secure manner. Being an immutable storage, blockchain ensures that data stored is not to be tampered or manipulated in any manner.
Additionally, crypto payments are backed by blockchain technology. This will facilitate the fast and efficient remitting of tax funds by anyone. So here the specific ways to utilize blockchain for taxation.
1. Instant transactions records: In order to accurately calculate taxes, the administrators need an accurate and current record of of financial transactions. Using blockchain technology for to record transactions in real time will be a great way to arm administrators with the information they need to prepare and collect taxes.
Blockchain technology records data fast and live. Users can use it as a database to update all incomes, and other necessary financial transactions. And since it is accessible everywhere, tax administrators can use this live and updated financial records to work on any taxes and have them ready. This will vastly improve the time taken to access financial documents and prepare taxes.
2. Immutable financial records: Blockchain technology will play a pivotal role in documentation of financial transactions and tax records. Today, many users evade taxes by under-reporting income or manipulating financial records in other ways. But blockchain technology is immutable by design. When users store their financial records on the blockchain, it is impossible to delete, modify or manipulate figures in any way.
When implemented, the system will be a real-time financial transactions portal for all users. They are expected to log all details on the blockchain. Tax officials will have full confidence in the accuracy of such records. Blockchain technology will ensure data integrity. Hence, the records could be used to accurately prepare tax documents based on the real figures saved there.
3. International taxation: Some large organizations perform overseas transactions. There are also individuals that try to hide their income by operating foreign bank accounts. For all these and more cases, blockchain technology could easily be used to solve them. As transactions are logged into the blockchain, they are permanently recorded no matter the location.
Since blockchains are not limited by location, all transactions could be accurately recorded and taxes prepared. Tax agencies of countries involved could also collaborate and make sure taxes are paid for all taxable incomes. The big role to be played by blockchain is in recording financial transactions no matter where they happen. Such records would be used by collaborating tax bodies from the countries involved to prepare tax documents.
4. Tax automation: Today taxes are often prepared manually and that takes a lot of time and resources. Web3 will offer smart contracts that could be used to remove most of the manual work. Tax authorities that use this blockchain approach could install smart contracts for individuals or specific financial transactions. For example, repetitive purchases or expenses could be automatically calculated when inputs are fed into the smart contract.
Without even getting physical officials involved, users could input figures into the smart contract and appropriate calculations which have already been programmed are made. This would simplify the entire tax calculation and payment processes for both the agencies and the user that wish to pay their tax.
Conclusion
The challenges with current tax systems are well pronounce and until they are solved, authorities will continue to loose revenue and experience other issues involving taxation. Web3 and blockchain in particular helps to keep immutable financial records which are necessary for tax calculations.
Blockchain data storage is live and transparent. Even when it comes to audit trails which I did not go into as one of the advantages, blockchain is still the best as it would be difficult to manipulate audit trails stored on the blockchain.
My perspective
The potentials of blockchain for tax is enormous. The biggest roadblock yet is that many governments and countries are still skeptical about web3 and blockchain technology. A few are completely hostile. But, it does not remove anything from the fact that blockchains could be used for taxation and they are effective.
Some countries though are forward in blockchain adoption. Countries like El Salvado could be used as testing grounds for such projects. Once they are able to have them work there, adoption will eventually happen in other places as well.