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Could blockchain become government’s best ally in driving tax compliance?

Two people working at laptop in office

Most people readily associate blockchain with cryptocurrencies, whose surges and crashes in value have generated speculation, headlines, and hype. But more and more practical applications are emerging in industry and government alike. Our latest whitepaper Blockchain for Tax Compliance explores in detail how governments can use blockchain to make tax compliance more robust and efficient for themselves, companies, and the public.

As governments work to tackle huge societal issues around the world—such as changing climates, demographics, and working practices—efficient tax compliance systems enable them to optimize the resources available and have a bigger impact on their country and the citizens they serve.

Blockchain explained in 20 seconds

Blockchain is a ledger that can be added to but not modified, making it very secure. Each entry is secured into blocks of entries, and each new block is linked to the previous one. Blockchain is historically known as a core part of the digital currency bitcoin but can be used for any transaction of value.

More than just bitcoin

While bitcoin has flown the flag for blockchain over the past decade, governments the world over are finding ways to track, trace, and build more trust into existing processes. In the United Kingdom, for example, the Food Standards Agency is piloting blockchain in a cattle slaughterhouse to improve transparency and compliance in the food chain. And in the United States, the Food and Drug Administration is exploring blockchain as a means of securing medical research data.

Building trust between governments and the public

Security, trust, and transparency are some of the main benefits of using blockchain, making it well suited to tax compliance. Because blockchain is an objective, mutually agreed-upon record of transactions, multiple parties can verify every step of a process. And it’s gaining traction: in November 2018, the European Parliament Special Committee on Financial Crimes, Tax Evasion and Tax Avoidance (TAX3) published a draft report which contains recommendations on fighting cross-border VAT (value-added tax) fraud. The report encourages member-states to explore the possibility of a plan to place cross-border transactional data on a blockchain and to use a secure digital currency that can only be used for VAT payments.

Reducing fraud, saving money

The authors of our white paper estimate the global tax gap—the difference between what is owed and what governments manage to collect—to be around $1.6 trillion. The global cost of collection is estimated at $1.3 trillion.

Blockchain offers enormous possibilities for governments to not only reduce that gap, but to reduce the cost of their tax-collecting operations, too. By allowing peer-to-peer transactions, blockchain reduces the cost of third-party transaction brokers.

Also, blockchain enables the use of “smart contracts.” Think of a smart contract as an automated set of rules between parties, which won’t allow steps in a process to happen until the previous process is verified as complete. So, for example, a company could automatically record events like transactions, purchases, and salary payments, and pay its tax bill based on what’s actually occurred rather than having accountants derive a figure from thousands of records. The reduction in time for both governments and organizations could be substantial.

Use cases for blockchain go beyond taxation

In part 2 of the white paper, we examine in depth how blockchain can help provide a tax infrastructure to stimulate ecotourism. This infrastructure would be especially relevant to regions with natural and historic sites that attract visitors, providing a boost to the emerging local and national economies. These visitors, however, can bring unwanted side effects, including increased pollution and noise, in addition to contributing to economic and social inequalities within destination countries.

By imposing a tourism levy on services—which could be a tax on travel or hotels, for example, or even a voluntary contribution—governments could raise funds to reduce the negative impacts of tourism while sustaining and promoting it.

A transparent ecosystem for public spending

And where does blockchain come into play? Blockchain works as a secure way of ring-fencing the collected tax funds to ensure that they are exclusively used for their intended purpose. In fact, through smart contracts, blockchain can increase the transparency of the entire ecotourism sector in a country. Tourists will be able to see where their tax contributions end up—and could even be allowed to select which projects receive funding or propose ideas for how the money could be spent. Through an app or website, they will be able to track the progress of projects through to completion, with complete transparency on spending.

The system could also incorporate contractors and project auditors to handle the processes of bidding for work and quality assurance. Records of tenders, bids, and audits could be tracked on a blockchain, with contractors being scored according to the quality of their work.

By logging the entire funding and development flow of ecotourism projects on a blockchain, with no risk of data being manipulated, all parties gain greater assurance and transparency. Moreover, it helps ecotourism destinations achieve two of the Sustainable Development Goals set out by the United Nations in 2016. These goals specifically relate to building effective, accountable institutions and strengthening domestic resource mobilization by improving organizational capacity for tax collection.

Discover how blockchain could work for your tax administration

Download your free copy of our white paper Blockchain for Tax Compliance, which explores the benefits, considerations, and use cases of blockchain for tax compliance. And listen to our podcast episode on Taxation and Transparency to learn more about how blockchain has the potential to make tax payments more secure while AI can help to increase compliance and reduce fraud—with a measure of empathy.