Decentralized Democracy: Methodology

Table of Contents:

1. Introduction
2. Methodology
3. Decentralized Democracy
4. Conclusion & References
5. Addition I. Class Summary

Methodology

Our goal is to design a system of contracts (SoC) that can allow a voluntarily associated group of people to establish a decentralized government and economy driven by democratic and market principles. Decentralized government consists of service providers that are financed by the group. We are going to put forward a set of requirements for the political, economic and computer networking rules that are supposed to govern group members and their service providers in the SoC.

Private and Public Choice

Market Failure. Given that markets are driven by the individual interests trying to maximize their personal utility, there are situations when markets do not lead to the simultaneous maximization of group utility. These situations can be characterized as markets failing to distribute resources efficiently. We’ll have to account for tradeoffs that, if unbalanced, can lead to decrease in group utility. Common types of market failure (Cunningham, 2011):

• Natural monopoly. Industries with high infrastructure costs such as water and electric utilities, transport networks do not allow for competition. The SoC must allow it to provide services that generally cannot be selected through the mechanism of market competition among providers. A group has to be able to finance an unlimited number of service providers that must cooperate with each other using a common pool of infrastructure assets.
• External effects. A situation when costs or benefits are shifted to a third-party. The SoC must allow it to reject services with high external costs. A group has to be able to select a contract that accounts for external costs instead of the one that doesn’t.
• Indivisibilities. A situation when the barrier to entry is too high or too low. The SoC must allow it to provide services that have a high barrier to entry. A group has to be able to finance service providers in order to overcome the barrier.
• Asymmetric information. A situation when there is a major discrepancy in knowledge about costs and benefits among market participants. The SoC must allow it for a group to finance specialized intermediaries that are going to perform information intensive services.
• Public goods. Services such as law enforcement and basic education do not inherently possess market incentives. The SoC must allow it for a group to finance service providers that provide public goods.
• Property rights. Markets are unable to function without full and complete property rights. A group has to be able to finance service providers that provide protection of property rights.
• Monopolies and oligopolies. Markets are unable to function without competition. The SoC must allow it for competition to emerge. A group has to be able to switch their preferences from monopolistic service providers to competing service providers.

Government Failure. The counterpart to market failure is the government failure which is studied by the discipline of Public choice. It allows us to analyze political systems through the economic lens and to describe a set of situations and tradeoffs when the behavior of different political actors such as politicians, voters and government agencies may not lead to the maximization of group utility. Common types of government failure (Butler, 2012):

• Decision-making vs. external costs. In the majoritarian voting system the cost of collective decisions ultimately has to be imposed on the minority as an externality. The cost of making a collective decision is higher for the qualified majority than for the simple majority, but the external cost is lower. Unanimity has the highest decision-making cost and the lowest external cost. The SoC must allow a group of voters to balance the costs of group decision making in relation to external costs that are incurred by the minority of voters in the group. For every set of contracts the group has to be able to choose the most appropriate set of voting rules that includes simple, qualified and unanimous majority voting.
• Indivisibility of public goods. Individual preferences cannot be expressed in the same way with public goods as with market goods. Public goods do not come as an array of possible options to choose from. Preferences for public goods are expressed through elections once in a time period which doesn’t allow for the same level of continuity as market choices that are being made every day. Public goods are usually not chosen individually as opposed to market goods but they come as a bundle of different policies for multiple sectors of the economy. The SoC must allow for a group of people to express their individual preferences in a similar way with public goods as with market goods. The SoC must be able to provide public goods as an array of possible options to choose from. Group members must be able to express their preferences continuously and be able to change their mind. The SoC must allow it to vote on a bundle of different policies for multiple sectors of the economy.
• Expansionary pressure. There are multiple forces that pressure the government to constantly expand such as special interest groups, the possibility for debt financing, the ability to shift external costs to the minority and policy bundling practices. In the SoC an increase or reduction in group spending must be determined by group members.
• Choice and outcome. While the outcome of a market choice is usually known, the outcome of a choice made by voting in a election for a candidate may be significantly different then what was actually voted for. The SoC must allow it to vote on proposals that are very specific in what their outcome is supposed to look like and who exactly is responsible for delivering it.
• Tactical voting. Voters may choose not to express their true preferences because they know that their preferred candidate is going to lose and instead vote for a more viable candidate. The SoC must not limit voters in the number of choices they can make such that voters are able to support multiple competing proposals.
• Voting system. There are two types of voting systems that are often used. First, each district elects one representative with plurality vote which often produces disproportionate results. Second, voters vote for political parties that propose lists of candidates which runs the risk of disproportionate influence of the party leadership. Therefore, mixed voting systems are often used instead. The SoC must allow voters to choose their representatives individually as well as lists proposed by political parties.
• Rational ignorance. Any one individual vote is statistically unlikely to change the outcome of an election while costs associated with making an informed choice for an individual voter are high. Therefore, many voters may not see the benefit to being informed in the first place. The SoC must allow voters to know that their vote is going to have an immediate impact that is not dependent on the vote outcome. The SoC must allow voters to know exactly what is the personal cost that is associated with their vote. When voting has an immediate cost, voters are more likely to get informed. The SoC must also allow voters to outsource information intensive tasks.
• Vote motive. Politicians tend to choose policies that increase their number of votes rather than those that reflect their true political position. The SoC must allow it for representatives to exist without the necessity to win the majority in an election and to just represent those voters who voted for them. Voters must be able to make any number of independent choices from a set of available representatives.
• Median voter theorem. Policies that receive the most voter support tend to be clustered at the political center. The SoC must allow it for a broad range of policies to be able to exist simultaneously.
• Democratic failure. There are situations where voters may act irrationally which may result in ineffective resource allocation from the economic perspective. The SoC must allow for a penalty for irrational voting behavior to exist. The costs of making a failed decision must lay only on those members of a group who made them.
• Special vs. general interests. General interest groups do not have proportional influence compared to special interest groups. The costs associated with special interests are shifted to the general public while the benefits are reaped only by those in the in-group associated with special interest. The SoC must allow it for general interests to be more proportionally represented.
• Vote trading. Bundling multiple policy proposals into a single proposal by a legislature and a practice by legislators of exchanging favors where they vote for each other’s proposals. The SoC must allow for transparent and explicit vote trading practices to exist.
• Rent seeking. Situations where the government creates monopolies by granting special legal privileges to a particular group of entities. The SoC must allow voters to balance the amount of rent seeking behavior.
• Budget maximization. The counterpart to the profit motive for government agencies. The SoC must allow for competition among service providers to exist.

Constitutional Political Economy

Governing the Commons. The tragedy of the commons characterizes a situation where some common resource gets depleted by its consumers because of their lack of coordination (Banyan, 2014). To counter the overconsumption of shared resources (Ostrom, 1990) developed a regulatory framework that allows groups of people to manage shared (common-pool) resources by establishing institutions for collective action. The SoC must allow a group of people to establish institutions for collective action to manage common-pool resources. There are following components of the framework that the SoC must have:

• Group membership. The SoC must allow it to establish group boundaries.
• Governance. The SoC must allow group members to establish rules that are well matched to their needs and conditions.
• Legislative power. The SoC must allow group members to influence the rule-making process.
• Traditional government. The SoC must allow for integration with the government.
• Executive power. The SoC must allow it for rule enforcement mechanisms to exist.
• Penalties. The SoC must allow for a graduated system of sanctions to exist.
• Judicial power. The SoC must allow for low-cost conflict resolution mechanisms to exist.
• Management. The SoC must allow it for multiple layers of nested enterprises to manage the common-pool resources.

Constitutional Economics. The field that studies potential new kinds of economic and political arrangements is called constitutional economics (Van Den Hauwe, 2005). Potential economic and political rules should be individually itemized. It is necessary to have some mechanisms for rule enforcement. Traditionally, only social enforcement mechanisms are utilized, the SoC must provide some alternative mechanisms for rule enforcement. Deviation from the rules shouldn’t lead to meaningful individual utility maximization. Rule enforcement and adherence should lead to individual utility maximization. Potential economic and political rules should focus on decision making mechanisms rather than trying to directly influence the economy and politics. Contracts in the system must provide decision making mechanisms within the rules. Changes in rules must be approved unanimously. All spending must specify how it’s going to be paid for.

Constitutional Catallaxy. The field that studies economic and political arrangements as a dynamic open-ended system of competition, coalition building and conflict resolution is called constitutional catallaxy (Salter & Wagner, 2019). Open-ended analysis is focused on the process of market and political actors converging on a set of prices and political agreements rather than on the process of personal utility maximization. The SoC can be viewed as a framework of constitutional rules for competition, coalition building and conflict resolution for a group of people that allows it to arrive at a set of prices and political agreements. One constitutional rule is preferable to another if it doesn’t result in a conflict between two separate groups. The SoC must be able to put forward rules that do not result in a conflict between two separate groups of people.

There is an inherent tradeoff between procedural liberalism and democracy that must be balanced by enforcement of constitutional rules. Traditionally, constitutional enforcement relies on social mechanisms and cannot be fully self-enforced, the SoC must allow for self-enforcement of certain kinds of rules. Procedural liberalism requires majority support and must be able to counter attempts at derailing it. Group members must be able to balance procedural liberalism and democracy. Constitutional order of the SoC has to be open to change and exploration of more beneficial arrangements through the process of constitutional entrepreneurship.

Monetary Constitutionalism. The field that studies potential new kinds of monetary rules is called monetary constitutionalism (Van Den Hauwe, 2018). The SoC should be simple. It is unclear what rules are the most optimal. Group members should be able to choose rules they think are the most optimal. Traditionally, rule enforcement in regards to the central bank is difficult and central banks have properties of a monopoly. The SoC must allow for self-enforcing rules in regards to the central bank and allow for non-monopolistic central banking. The SoC must allow it for a group of people to balance the tradeoff between commitment to rules and administrative discretion. The SoC should be self-enforceable. It should be impossible to intervene with the SoC.

The SoC should provide a framework for economic activity. The SoC should be able to restrict a set of choices that can be made within the framework. The SoC should be able to account for costs and benefits of choices that were made by group members. The SoC should be able to establish a limit on currency supply.

The SoC must be proven to be more optimal. The SoC may be both market-driven and government-driven. Rules of the SoC must be agreed upon by a group that is subject to them. Costs and benefits of proposals to the group must be presented clearly. The SoC must account for imperfect information and self-interest. The SoC must provide incentives that maximize group utility. It should be beneficial for service providers in the SoC to follow the rules.

Polycentric Banking. The field that studies potential banking systems that do not have a central banking component is called polycentric banking (Salter & Tarko, 2017). The SoC must allow a group of people to establish banking rules that do not rely on central banking but rather on polycentric banking. Polycentric banking rules must adhere to design principles of (Ostrom, 1990). Credit should be viewed as a common-pool resource. The SoC cannot assume that all actors in the system are going to behave rationally, have perfect knowledge or be altruistic; and that all actors are going to act in the interest of the group rather than their own. A group should be able to choose from a set of services and be able to discontinue a service. Rule creation and enforcement must not require a single entity but rather a collective of entities that cooperate and compete with each other.

Fiscal Federalism. The field that studies how to maximize group utility when distributing fiscal responsibilities among central/federal and regional levels of government is called fiscal federalism (Driessen & Hughes, 2020). It describes situations and tradeoffs when one level is preferable to another. Each group of people both on central and local level must have its own dedicated SoC. Local level groups should be able to require their members to join central level groups. It must be possible to distribute fiscal responsibilities among the groups.

• Varying Preferences. Increase of variability in individual preferences among regions leads to increase in responsibilities of local governments. If variability in individual preferences among local level groups increases then responsibilities of local groups must be able to increase.
• Mobility. Increase of variability in responsibilities of local groups leads to increase in competition for residents among local groups.
• Spatial Effects. When responsibilities are specific to a geographical region, local groups are preferable. When responsibilities span multiple regions, central groups are more preferable.
• Externalities. The situation when a local government receives benefits or costs from another local government. When a local group receives benefits or costs from another local group, voters must be able to choose contracts that account for external effects.
• Government Effectiveness. The situation when the same responsibility has lower or higher costs for one group level than another one.

Participatory Budgeting. A fiscal framework that allows for collective decision-making (De Soysa, 2022). Presently, participatory budgeting is the most viable on the local level in rural communities. The SoC must allow it for a group of people to establish a fiscal framework that allows for collective decision-making. The SoC must allow voters to have influence over four main stages of the budget cycle: formulation, approval, execution, and oversight. The SoC must be able to provide participatory budgeting on both national and local levels in both rural and urban communities.

Liquid Democracy. A combination of direct and representative democracy (Valsangiacomo, 2021).

Ranked Choice Vote. A voting system where voters cast their vote as a ranked list of candidates (Ballotpedia, 2018). The rules must specify the length of the list.

Quadratic Vote. A voting system where voters can trade their vote (Posner & Weyl, 2017). Each voter is apportioned a certain number of voting units that they can either vote with or sell. Voting units that were given in favor of a proposal by a voter are converted into votes with the square root rule. For instance, one unit equals one vote, four units equals two votes, nine units — three votes and so on.

Flexible Majority Rule. The traditional majority vote system sets a fixed threshold that is required for winning such as 1/2 or 2/3. A voting system where the higher the currency growth rate is the more votes are required to approve it is called flexible majority (Gersbach, 2022).

Futarchy. Decision markets and prediction markets allow betting on outcomes of particular events (Hanson, 2006). Theoretical method of public policy selection through prediction markets is called futarchy. We can take the idea of public policy being selected by a market mechanism that is presented by the original futarchy, and substitute one market mechanism for another. Instead of the prediction market we can apply the stock market. The SoC must allow it for a group of people to select public policy proposals by listing them on an exchange and then adopting those that trade at higher prices. The SoC must allow it to build new policies on top of the old ones such that investments in the old policy retain some of their value as the new one is adopted and the old one is discarded.

Decentralized Networks

Decentralized networks allow to coordinate network participants without a central authority. There are limitations to market-driven governance and trustless architecture of decentralized networks (De Filippi, 2019) that the SoC must provide an alternative to. The SoC must allow network participants to express trust. Governance of the SoC must be designed to increase group utility. There is an inherent tradeoff in security between centralized and decentralized governance that the SoC must allow group members to balance.

Constitutions establish meta-rules of a system (Berg et al., 2020), the SoC must establish meta-rules for a group of people. The SoC must allow the group to establish a decentralized network that produces a constitutional order that is beneficial for competition and cooperation among group members. Network rules must not determine individual outcomes of group members. The decentralized network must be able to establish a process of dynamic and open-ended rule development. Network rules must be determined by network participants. The group must be able to balance the inherent tradeoff between maintaining the rules and changing the rules. Coordination among participants of a decentralized network leads to improvement of the network.

Evolution of protocols can be divided into three stages. First stage is a centralized institution establishing a shared protocol such as HTTP. Second stage is a shared protocol establishing a decentralized institution such as Bitcoin. Third stage is when an institution itself is shaped by a shared protocol (Lustig, 2019). The SoC must allow a group of people to establish a shared protocol that is able to shape the structure of institutions that govern the group.

Decentralized networks should be able to facilitate economic cooperation and democratic processes, they have a potential to overcome limitations of traditional democracy (Davidson et al., 2016). The SoC must allow for a group of people to establish a decentralized network that allows it to govern common-pool resources. The SoC must allow for collective choices at the lowest level of authority. The SoC must be able to provide an institutional alternative to the government and the market for economic coordination.

Evolution of decentralized networks can be divided into three stages. First stage is basic cryptocurrency like Bitcoin. Second stage is cryptocurrency plus smart contracts. While the first two stages relied on volunteer network hosts that are driven by market incentives, the third stage takes a democratic approach. It allows network participants to vote on network hosts that are financed through taxation (Berg et al., 2018). The SoC is supposed to be a decentralized network of the third stage.

There is an inherent tradeoff between globalization and localization of production. An economic model that allows for sharing of knowledge and protocols on the global level and manufacturing on the local level is called cosmo-localism (Manski & Bauwens, 2020). The SoC must be able to facilitate cosmo-local production.

A shared network of selected nodes is called consortium blockchain, it is not computationally intensive and has a high throughput (Elisa et al., 2019). The technology that allows for data to be hosted without the host being able to read the data is called server-side encryption (Song et al., 2000). The SoC must allow it to establish a shared network of selected nodes that use server-side encryption.

The way to package software that allows it to be run independent of an operating system is called virtualization. Such a package is called an image. Image can be used to spin up an unlimited number of network containers that all run the same computer programme (Silva et al., 2018). A group of people must be able to establish a shared network that allows it to run software packages independent of an operating system of the network.

Decentralization Failure

The main promise of the cryptocurrency tokens was to become a financial instrument that could potentially allow small and medium sized businesses to raise capital without obstacles that are posed by the high barrier to entry into the stock market. With traditional stocks it is hard to get listed on a reputable stock exchange and get rated by a reputable rating agency, and to be able to pay for a board of directors to ensure proper oversight. Only the bigger market players can afford it. Ultimately, the token concept has failed to deliver on its promise due to the lack of key components that are precisely the obstacles that it tried to avoid. Absence of the proper legal status and oversight, and of the stock market infrastructure that is necessary to support it, and of small and medium sized institutional investors who would be interested to invest in it make cryptocurrency tokens not a particularly viable financial instrument.

The main promise of the DAO fund concept is that it could allow it to create institutional investors that are not bound by the restrictions of the stock market. Traditionally, an institutional investor has to obtain membership at a reputable stock exchange and invest only in assets rated by reputable rating agencies. Ultimately, the DAO fund concept has failed to deliver on its promise due to the lack of key components that are precisely the restrictions that it tried to avoid. Absence of the proper legal status and oversight, and of the stock market infrastructure that is necessary to support it, and of potential investment opportunities that traditionally present themselves through the stock exchange make DAO fund not a particularly viable financial institution.

(Allessie et al., 2019) have concluded that the recent developments in decentralized technology did not translate into the public sector:

Contrary to how it is often portrayed, blockchain, so far, is neither transformative nor even disruptive for the public sector. We have not observed the creation of new business models, the emergence of a new generation of services nor direct disintermediation of any the public institutions involved in the provision of governmental functions. Truly transformative services which enable decentralised voting or civic governance without direct involvement of governments are missing from the current landscape.

What this paper is trying to show is that there is a way to accomplish exactly the things that the current strain of decentralized technologies has yet failed to accomplish. Concepts such as crypto tokens and DAO funds that were supposed to be the avant-garde of financial decentralization appear to be not sufficient to create a complete market and public sector ecosystem just by themselves. Because an army can’t just consist of the avant-garde, there must also be the arrière-garde. The support infrastructure layer that is supposed to service and connect an asset issuer to an asset consumer is currently missing in the world of decentralized finance. Although there are stock exchanges for digital assets, they specialize mostly in international finance and focus only on the bigger players, just like the traditional stock exchanges. Oversight in the form of boards of directors, rating agencies and financial regulators is non-existent. What we need is a decentralized market and public sector ecosystem that is complete and that can function on any scale.

Democracy

Group members must be able to delegate as well as to vote directly. A group has to be able to choose among different types of voting procedures such as simple, qualified and unanimous majority vote or anything in between, flexible majority vote, ranked choice vote and quadratic vote as well as market selection procedures such as futarchy.

Traditionally, when there is an election or referendum the thing that is being voted on is some position of authority in the government or some policy. In a decentralized voting system we can allow it to combine the two, meaning that a group can vote on a policy that is attached to an authority that is supposed to implement the policy.

Requirement 1 — Clarity. A contract must be clear in what it allows to do. The terms of the contract have to be designed in such a way that a voter must be able to know exactly what actions the contract allows to perform. Only under this condition can the voter make a decision that can be qualified as informed.

Requirement 2 — Privacy. A voter may have a reasonable expectation of vote privacy and secrecy. Generally, the SoC must provide both privacy and anonymity of user data under the condition that authorized access may be granted to entities selected by a group.

Requirement 3 — Majority vs. Minority. Although contracts are approved by the majority of the vote, the voters who are in the minority must have an ability to protect themselves to some reasonable degree from possible negative consequences of decisions made by the majority. Votes that are in the minority must still count to some extent and must still be able to have some impact on the system.

Decentralization

Decentralization doesn’t mean getting rid of the center, rather it means moving the center somewhere else. In our context it means moving the center towards new institutions (Davidson et al., 2016) that are going to be governed by liquid democracy and market incentives. Anytime we require an analogue for a traditional institution or a new type of institution that wields some kind of societal authority, we are going to implement it with a contract that can be selected by group decision-making and that clearly outlines its costs and benefits.

There are two layers that we must act upon in order to construct new institutions: computer networks and human networks. The former we can do pretty much anything with. The latter we have no real control over, apart from the incentives that we hard code into the former. There are some rules and constraints that can exist on the computer networking level, and those we can be sure are going to be enforced with full certainty. But for many other types of rules it is impossible to program them in. Therefore, the SoC must allow for a group of people to construct interconnected social and computer networks that act in synergy with each other to maximize group utility.

New kinds of institutions will require their legal status to be defined in the same way as it is defined for corporations (Nielsen, 2020). For instance, principles of non-discrimination must apply to the services that are provided by the new institutions. The legal status of rules produced by the new institutions should be similar to organizational and municipal by-laws. Decentralized government cannot override federal government, or if it can then only within the established federal framework of precedent. Decentralized government can have its own enforcement systems and self-structure but one that doesn’t fall outside the Constitution.

In the traditional elections and referendums it is assumed that the will of the people is going to be carried out through the government. In our case it must be carried out through institutions that are set up by the SoC that are selected by a group of people. All participants in the system must agree to the rules in order to participate.

In the traditional legislature the power to write laws, introduce them for the vote and vote on them is centered in a singular institution. In our case the SoC must allow for separate institutions to be responsible for the tasks of writing, introducing and voting on legislation. There must be an unlimited number of institutions that can perform these tasks.

The SoC must be compatible with the traditional government. The SoC must allow it for a group of people to finance the traditional government. There are certain areas that are impossible to decentralize such as response to disasters, pandemics and foreign military invasions. The SoC must allow it for central and decentralized governments to cooperate and compete in a way that leads to group utility maximization.

Requirement 4 — Autonomy. The SoC has to be autonomous such that no single party to a contract is able to unilaterally override the terms of the contract. A voter must be reasonably sure that the contract they voted for remains in the same exact form that they voted for for the period specified in the contract.

Requirement 5 — Monetization and Seed Funding. A contract must be designed to allow the service provider that proposed the contract to somehow monetize their activity, meaning providers must be able to receive some kind of payments for their services. And not only that but also contracts must contain instruments to raise start-up capital.

Financial System

Monetary System

The SoC that is used by a group of people must provide its own fiat currency system. Every group has its own currency. Groups can then establish a link between their financial systems. The currency system must provide both fixed and variable currency creation mechanisms.

Requirement 6 — Credit Supply. The system of contracts must allow for money to be created as credit as well as the result of foreign exchange operations. Money creation is determined by voting on a set of contracts. Contracts may be proposed by service providers, providers must specify all necessary contract parameters when proposing a contract, there can be an unlimited number of contracts that can be proposed and an unlimited number of providers that can propose them. There are following possible types of money creation contracts:

• Commercial and consumer credit. Interest rate and payback period must be specified for every contract such that voters can make an informed decision. The amount of credit that a contract can provide can be of the following types:
  - Fixed. Fixed amount of currency that can be created.
  - Reserve. The amount is determined by reserve requirements.
  - Algorithmic. The amount is determined by a computer programme.
• Decentralized government spending. The amount of spending and individual income tax rate must be specified for every contract.
• Open Market Operations. The amount that can be used for sale or purchase of securities and the amount of reserves that can be loaned on the interbank market must be specified for every contract. Technically, these amounts can be set to infinity in which case the behavior of the decentralized monetary system is going to be analogous to that of the traditional monetary system.
• Foreign Exchange. Contract must specify an exchange rate for foreign currency.

Requirement 7 — Credit Repayment. To illustrate one particular mathematical effect on the currency supply, let’s expand on the example from (Bank of England, 2019). There is one commercial bank and two customers A and B. We assume that we start out with the total currency supply of zero. Both customers take a loan of £100 at five percent from the bank. The total currency supply is now £200. When customer A returns their loan to the bank then the total currency supply becomes £95. It is now not mathematically possible for customer B to return their loan, and they are now in a situation where their only options are either to default or to take out another loan.

It has to be possible for the SoC to be in a state where it is mathematically possible to cover all debt obligations in the system such that currency supply equals or is greater than zero. The contradiction presented in the example above can make a financial system mathematically inconsistent. It is important to provide group members with an instrument that can allow them to expand the currency supply without expanding debt at the same time.

Additionally, as opposed to the traditional fiat currency that is not supposed to ever disappear, a decentralized fiat currency must have an ability to shut down if a group of people decides to disband. During the shutdown process all existing obligations have to be covered for the shutdown to complete successfully and that requires that all obligations can actually be covered.

Fiscal System

In the US individual income tax accounted for 50% of the federal tax revenue in 2019, and the payroll tax — for 36% (Tax Policy Center Briefing Book, 2020). It means that the primary task for the SoC is to enable taxation in the employer-employee context.

It should also be noted that yearly government spending is comparable in size to the overall wealth of the private sector (Kertscher, 2021) which means that it is quite a substantial amount. However, it is not the goal of this paper to suggest that taxes and government spending should be lower or higher. Instead the goal is to design a general framework that can allow it to implement any particular policy in the most optimal way.

Decentralized fiscal system must allow for budgets and taxation to be determined by a group of voters. However, as per Requirement 3 voters who are in the minority must be able to shield themselves from bad budgeting decisions. Taxation is a pretty heavy-handed instrument and voting is a pretty crude instrument. There must be an additional mechanism that will be able to counterbalance these drawbacks. And the mechanism is to introduce additional costs for the majority for making bad budgeting decisions.

To understand the balancing mechanism let’s look at a simple example. There are three houses owned by persons A, B and C. They make an agreement to pay a construction agency to build a road. There are two construction agencies X and Y that are competing for the project. The budget for the project is m, each person must contribute m/3. Persons A, B and C vote on which construction agency gets the project. Let's say A and B vote for X, and C votes for Y. The agreement says that if C doesn't believe that X is going to deliver the project and the budget is going to be wasted, then C can invoke a special provision in the agreement. The provision says that if the project fails then A and B must both pay m/6 to C. If the project doesn't fail then C must pay m/3 to X.

Such contracts must include special provisions for unforeseen events. Decentralized government must have its own conflict resolution system that is going to have to decide whether the default event falls under the punitive provision established by the contract.

Requirement 8 — Government Spending. Group members must have an ability to know in any given state of the SoC how much money can the decentralized government spend as per Requirement 1 that all contracts must be clear in what they allow to do. Each budget item must also include the means of financing of expenditures set by the item.

Requirement 9 — Spending per Representative. The United States House of Representatives has 435 members and the federal budget for the 2020 fiscal year was set at $4.79 trillion. It amounts to 0.09 representatives per billion dollars in a single vote.

Let’s assume that we can vary the number of representatives. It would require approximately 4833 representatives to achieve the rate of one representative per billion dollars. Voters in the decentralized fiscal system must be able to vary the rate of the number of representatives per certain amount of currency units.

Requirement 10 — Budget Itemization. There must exist strict itemization of the budget and separate vote on each item rather than one vote on the budget as a single document. It must be possible for every budget item to be voted on independently from any other item.

Stock Market

When designing the SoC, we are going to focus on creating incentives for long-term investments. If there’s no demand for long-term obligations then there’s going to be no supply of long-term obligations, hence no incentive to build institutions and make long lasting investments. Many developing countries do not have a functioning stock market and even in developed countries it is practically non-existent at the level of small and medium sized businesses.

Often the main barrier to long-term investments in developing countries is the lack of trust. When financial and other institutions of a country are not well developed, potential investors of a pension fund are afraid that their contributions are simply going to be stolen by the fund manager or that the fund is simply not going to be there anymore when the time for repayment comes.

Requirement 11 — Security. A contract that handles financial obligations must be designed in such a way that an investor can be reasonably sure that their investments cannot be stolen if the contract was configured in the right way.

Requirement 12 — Oversight. Another major hurdle that forbids small and medium sized companies from going public is that paying for a board of directors is prohibitively expensive for the company. The SoC must allow shareholders to fund the boards of the companies whose stocks they are invested in.

Requirement 13 — Locality. When an investor invests into a portfolio fund, the investor must have the possibility to be reasonably sure that the fund can then make investments on their behalf only in a specific geographic area on the municipal, regional or national level. It is going to give an opportunity to a group of people to become financially invested into their own community while still keeping the option for personal portfolio diversification.

Technically, in the traditional system nothing prevents institutional investors from imposing such restrictions onto themselves voluntarily. But it is just not going to be profitable to invest in local assets compared to national and international assets. So investment funds do not offer it as a service to specialize location. The SoC must allow it for a group of people to make a choice to sacrifice some profitability in favor of investing in the community they live in. When presented with the choice on the group level rather than individual, it is more likely for a group to balance its investments in favor of locality.

Requirement 14 — Infrastructure. The SoC must allow for the stock market infrastructure of oversight bodies, stock exchanges, rating, insurance and regulatory agencies. The SoC must allow group members and investors to create regulatory and oversight institutions.