Opinion: The Senate’s pursuit of cryptocurrency tax dodgers

According to Congress’ tax experts, people who invest in cryptocurrency evade billions of dollars in capital gains taxes every year.

That’s one reason the U.S. Senate has set its sights on cryptocurrency exchanges such as Coinbase and Binance, where people buy and sell Bitcoin and other digital currencies. To help pay for a new infrastructure bill, its bipartisan sponsors want the exchanges to report their users’ sales to the Internal Revenue Service, just as Vanguard, Fidelity and other Wall Street investment companies have to do.

According to Senate staff, tax cheating is most common in the types of income where there’s no third party keeping track — when the only information coming to the IRS is what taxpayers report about themselves. Put another way, people who make all their money through wages don’t have the chance to evade taxes the way Bitcoin investors do.

Cryptocurrencies are unlike shares of GameStop or Apple in one important respect: People can buy and sell digital currencies anonymously. In fact, that’s part of the appeal. Nevertheless, if you’re going to turn digital currency into money that can be spent freely and easily, someone needs to know your name and bank account number. So at that point, when a capital gain or loss is realized, the veil of anonymity has been lifted.

So if Congress just focuses on the points where bits become dollars, tax enforcement should be easy, right? Except that it isn’t simple at all. Crypto advocates and civil liberties organizations erupted when the text of the infrastructure bill was released, arguing that the language was written far too broadly. In their view, many of the people involved in creating and maintaining the blockchains behind cryptocurrencies would be required to learn who their users were and to report that information to the IRS.

“The mandate to collect names, addresses, and transactions of customers means almost every company even tangentially related to cryptocurrency may suddenly be forced to surveil their users,” Rainey Reitman of the Electronic Frontier Foundation warned. The new obligations were so incompatible with the crypto ethos, advocates said, crypto companies would flee the United States for less prying environs.

Sen. Rob Portman (R-Ohio), the author of the cryptocurrency provision, sought to calm the waters, tweeting that the target of the provision was the exchanges, not the miners who maintain the digital transaction ledger, the wallet services that enable people to store their cybercurrency or others with roles in the blockchain. And on Wednesday, Sens. Ron Wyden (D-Ore.), Cynthia Lummis (R-Wyo.) and Pat Toomey (R-Pa.) unveiled an amendment to clarify that the reporting requirement did not extend beyond “persons who conduct transactions on exchanges where consumers buy, sell and trade digital assets.”

That amendment, which Portman endorsed, seems to have quelled the controversy. But the episode raises a troubling question.

Crypto investors were targeted not just because of the alleged tax avoidance, which the congressional Joint Tax Committee estimated at $28 billion over 10 years. More important, cracking down on crypto tax dodgers didn’t require a broad and costly investment in the IRS’ enforcement personnel and capabilities, unlike the bill’s original framework, which Senate Republicans could not abide.

But should lawmakers care about just this one type of tax dodging? Given that the problem is orders of magnitude larger than $28 billion over a decade, it seems almost arbitrary to focus on cryptocurrency trades — it’s like going after piggy banks instead of Wells Fargo.

That’s not to say cryptocurrency investors shouldn’t be taxed the same way as investors in mutual funds and meme stocks. At least it’s possible now. But if cryptocurrencies ever become widely accepted as a form of payment, people won’t have to cash out their Bitcoins to buy goods. At that point, the IRS will truly be dependent on people disclosing their cryptocurrency capital gains to the taxman, who may have no other way of knowing about them. Good luck with that.