I am (mostly) bullish on crypto and (usually) skeptical of higher taxes, especially on capital gains. So why do I think it would be wrong to make crypto assets exempt from capital gains taxes, as President-elect Donald Trump’s administration is reportedly considering?
The most obvious argument against the proposal is simply that uniform taxation is better than selective tax exemptions. If a lower capital gains tax rate is preferable, then the goal should be to make a smaller cut that applies to all assets. Exempting a single kind of asset is likely to lead to abuses. You might think that boosting crypto is important now, but which sector or asset will be selected next for special treatment? It may be one you don’t think deserves it.
Overall, selectively low tax rates become a way of running fiscal policy off the books without requiring direct expenditures. In the long run, they create greater incentives for political lobbying and favoritism. Of course those are hardly new phenomena in the US, but why make them worse at the margin?
Many of the leading supporters of Trump’s campaign were crypto-connected companies. You don’t have to think this tax proposal is some kind of payback to realize that this creates problems of perception. Next time around, companies will offer campaigns financial support in the expectation of more favorable tax and regulatory treatment.
Another problem is that tax exemption is probably not the best route to crypto normalization. What crypto assets and institutions require is predictable treatment, and on that score the nomination of Paul Atkins to lead the SEC is a good sign. Is a capital gains tax rate of zero even sustainable? A future Democratic president could raise the rate back to standard levels, or higher yet. The crypto industry would still be whipsawed by politics.
A tax exemption for crypto also would skew the population of crypto investors, and not necessarily in a beneficial fashion. The US economy offers a variety of options for tax-free savings, ranging from 401(k) plans to IRAs to pension funds. These vehicles make the most sense for investors who are liquid enough to put aside some money and lose immediate access to their funds.
It would be unfortunate if crypto became a preferred tax-free savings vehicle for lower-income groups. Crypto prices may well remain volatile in the future, and crypto investments are still more likely to be associated with scams and questionable business practices. This is obviously true even if you, like me, see plenty of legitimate uses for crypto assets and institutions.
In a world of tax-free crypto, those most likely to hold crypto are also among the least likely to have fancy lawyers to minimize their tax burdens. It would be better if the incentive to hold crypto were strongest for diversified, well-capitalized institutions with financial expertise.
Another issue is one of tax arbitrage. If crypto assets truly are not taxed on their capital gains, many other investment vehicles might, over time, be repackaged in crypto form. Rather than holding some equity in a company, why not hold a crypto token backed by that same company? That is hard to do under today’s laws and regulations, but it may well become easier under a Trump administration, which seems committed to the normalization of crypto. That normalization, however beneficial it may eventually prove, should not be allowed to serve as a way to dodge taxes.
The best argument in favor of the incoming administration’s proposal is simply that crypto is a different kind of asset, not money itself but like money in some ways. If you “sell” your money, say to buy a car, the government does not tax you on that transaction, claiming that you earned a “capital gain” on your money. So why should you be taxed on the capital gains if you used crypto to buy a car? Furthermore, sometimes crypto assets are turned over very rapidly in succession, for instance as a part of arbitrage in DeFi systems.
As those practices grow and become more normalized, they will require complicated adjustments to tax law. But it is unlikely those adjustments would be tougher than all the changes necessary to prevent various forms of tax arbitrage through tax-free crypto. Crypto assets also come with very good record-keeping systems, which should ease tax preparation burdens.
It is entirely appropriate to want to create a workable and predictable regulatory environment for crypto. But it’s important not to go overboard and give crypto preferential treatment.
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