Decentralized Autonomous Taxation (DAT)

Blockchains facilitate frictionless coordination between disparate parties. The distributed protocols and incentive alignment revolutionize organizational structures, providing an alternative to centralized authorities. As a result, many technologists envision leveraging decentralized autonomous organizations (DAOs) to build a world of fairer games with more winners, that can enable greater wealth distribution and equality.

The growth in dApps and DAOs over the past year suggests an increasing appetite for public governance, but there is limited insight into which decentralized decision-making processes can be successfully executed at scale. Will there be diminishing returns of decentralization to enable human collaboration, or will it be possible for individuals to collectively mandate any kind of behavior without an intermediary? Furthermore, for platforms that aim to more efficiently allocate wealth for greater equality, could the community coordinate and sufficiently self-incentivize cooperation to enforce economic policy like decentralized autonomous taxation (DAT)?

Per John Locke’s Second Treatise of Government, public taxation is the most widely adopted solution for creating a feedback loop of capital, whereby individuals pool resources to invest in social and economic development, while the duty of execution is delegated to the government. Although charity is meaningful and individuals can choose beneficiaries, it’s doubtful that voluntary contributions support sustainable development. By leveraging decentralized technology and incentive mechanisms, users could self-impose a DAT to sustainably allocate funds, and complement existing government spending to support economic objectives.

Death and Taxes

Taxes are characterized as inevitable (and as undesirable) as death. They are typically levied by central authorities that finance developments and earn revenue, in return for public service provision. Despite a general distaste for taxes, there is significant evidence of the positive impact of fiscal policy on achieving social objectives. The combination of direct taxes and cash transfers increase wealth distribution and on average, improve national gini coefficients (a metric for income inequality) by about one quarter across OECD advanced economies.

Moreover, when comparing low-tax nations (e.g., US, UK, Canada) to high-tax nations (e.g., Norway, Sweden, Denmark, France), research has shown that higher taxation can lead to lower poverty rates.

Throughout history, nations have experimented with various direct and indirect tax policies, such as property, income and sales taxes, head/poll fees and even religion-based taxes, amongst others. Taxation originated in Ancient Egypt, where grain was collected from citizens and redistributed during festivals to incentivize infrastructure development or to maintain a government grain surplus.

The Ancient Greeks and Romans levied taxes to sustain local economies amidst conflict. During the Zhou dynasty, the Chinese government instituted a property tax that required citizens to forfeit all proceeds earned from production on their land. While in the 17th century, John Locke asserted in The Second Treatise of Civil Government that for an administration to fulfill the duty of facilitating the social contract, citizens must pay for the cost of public services.

Yet despite centuries of taxation, it remains unresolved which tax schemes are most optimal to appease public service providers and the people, and achieve the greatest income equality. This suggests that the scope and execution of taxation continues to evolve as economic circumstances shift. As such, it is fair to assume that a global movement towards decentralized ideologies and systems through proliferation of blockchain technology, could also drastically alter the role of taxes in supporting public welfare.

It will be interesting to see how the ecosystem evolves and whether decentralized governance can surpass moral imperative into social enforcement.

This begs the question of whether users of decentralized governance could self-mandate fiscal policy like taxation to support wealth distribution and public services; especially if they can play a more active role in deciding how funding is disbursed. By nature, a tax is an enforcement, but does it matter who enforces a tax or simply how it’s enforced — can the power of taxation be certain, if not levied by a centralized, government authority?

Compliance & Bonding

Governments enforce taxes by ‘bonding’ citizens to incentivize alignment with canonical taxation policies. Born into a structured society, citizens immediately collateralize themselves. A citizen’s degree of tax compliance can impact their:

  1. Access (e.g., identity, entry to public services, imprisonment for evasion)
  2. Financial Capital (e.g., tax evasion penalties, tax liens)
  3. Social Capital (e.g., criminal record, credit scoring)

If Alice (a Canadian) evades taxes, she won’t have access to public health care, would have difficulty obtaining government-issued identity, would have to pay financial penalties and could face a felony sentence. Governments succeed in mandating fee-based policies by either directly limiting citizen rights or forcing non-government organizations to limit activity as well (e.g., taxes evaded → no ID → Alice can’t participate in a KYC-compliant ICO).

Similarly, blockchains have incorporated bonding mechanisms that impact user access and financial capital, to incentivize compliance and discriminate sad paths in interactive games. As Joseph Poon explained at Deconomy Blockchain Conference, “mechanism design is where we have a goal and we’re designing rules and a landscape in order for people playing game theory to reach this goal on their own self-interest”.

To be a validator in proof-of-stake consensus, stakers must provide a bond that can be slashed in the event that an invalid transaction is processed. Plasma child chains also leverage lock-ups to disincentivize users from invalid exits onto the root chain. Additionally, governance, dispute resolution and debt-based systems maintain bonding to ensure that voters, challengers and loan recipients have ‘skin in the game’ to act fairly. In extreme cases, bad actors can be banished from platforms altogether (caveat: only possible in conjunction with a sybil attack-resistant identity solution).

When it comes to social capital, the public nature of blockchains means that they facilitate perpetual reputation-building. Depending on privacy implementations, user activity is socially collateralized and the resulting reputation can also pervade applications and chains. For example; token curated registries attempt to derive a set of quality participants for various use cases, based on their past performance (e.g., voting, service quality).

Evidently, the inherent ‘skin in the game’ enforced by both governments and DAOs encourages compliance — there is a ceiling to how much an individual can live her best life if she doesn’t pay taxes, and users of web3.0 platforms must be willing to accept bonding and slashing conditions to participate. It is clear that the concept of mandate is subjective and simply implies that an individual’s self-interests align with the incentives to comply and work towards a certain goal.

However, as blockchains are opt-in ecosystems, it is unclear whether they have enough clout to enforce participation, consensus as well as economic policy. To implement a DAT, users would have to firstly desire to use a blockchain-based platform and then be sufficiently incentivized to feel that tax contributions are in their and the public’s best interests.

Power of the People

“The power of the people is much stronger than the people in power” — Wael Ghonim

In the absence of a DAT that is mandated by some kind of slashing mechanism, additional fee or service denial, DAOs could lean on reputation or social inclusion to drive participation.

Source: Black Mirror. Season 3, Episode 1. 21

Season 3, Episode 1 of Black Mirror is a fine example of the power of social engagement to enforce behavior. It’s secretly everyone’s favorite episode as we’re all petrified but intrigued by the impacts of the social ranking society that we are moving towards. In the episode, the social ranking platform is not government mandated yet the stigma associated with a poor reputation is so severe that it guides and often mandatescertain behavior.

In 2018, the Chinese government officially began implementing a formal social credit system that assesses a multitude of metrics including driving abilities, smoking habits and contributions to fake news, to incentivize good behavior. The implications of a citizen’s score can vary from being labeled a “bad citizen” to being denied access on planes and banning children from the best schools. (Note: I am not advocating for extreme citizen ranking but rather showcasing the power of reputation systems.)

More loosely, social apps like Instagram, Facebook and Twitter act as ‘social ranking systems’ based on user engagement metrics (likes, comments, followers). Social norms on these apps are more than just guidelines as lack of adherence can deem negative social consequences — sometimes limiting access, social capital and financial capital depending on a sub-group’s values (e.g., recruiter reviews of candidate’s social media, LinkedIn endorsements, “thought leadership” status).

Furthermore, social mandate impacts business and policy decisions as well. An example of this was the rise of third-party payment and data providers like Intuit’s Mint that began scraping banking platforms for customer financial data. Out of fear of losing customers, banks began opening their APIs voluntarily…or was it socially directed? The consumer push was so severe that it even led to reactionary policy implementations like PSD2 and CMA that legitimized user control over their financial data. If entities have the flexibility to opt-into business models, yet social pressures evolve, is it obligatory or voluntary? Could a proof-of-participation and thus reputation be a sufficient metric to incentivize participation in a public platform with a DAT policy?

Social beliefs like market speculation on asset value could also dictate behaviors. For example, in neighborhoods with high crime rates, homeowners would likely make efforts to fight localized crime to mitigate property value depreciation. In the context of a DAT, it could be socially enforced if a digital asset’s value or the allocation of digital assets was derived from a user’s compliance to the tax (e.g., tax-mined tokens). This kind of incentive system is synonymous with the Henry George Theorem where the raising of public revenue through a tax can result in increased “rent” for participants (e.g., land value accrual or rent). With a DAT the “rent” earned could be digital asset acquisition and appreciation.

Decentralized Taxation In Practice

It has become clear that the lines around enforcement are murky and the power of the public is vast. As decentralized technologies and cryptoeconomics become more pervasive, micro-economies will form with their own monetary and fiscal policies that incentive unique behaviors. Various mechanisms and reputational tools will be used to explore social mandate to support public wellness.

If platforms implemented localized DATs where the funding for niche economic objectives was subsidized (e.g., more school psychologists in US regions with high gun violence); and lack of compliance led to publicly-defined disincentives like slashing conditions, higher fees or ratings — a tax would essentially be mandated. If users were bonded to adhere to a DAT, then regardless of the administrator, it could be enforced.

Decentralized taxation is not unrealistic. The decentralization theorem of taxation asserts that a distributed tax system can be superior to centralized taxation, if there is effective tax coordination. Currently this is practiced globally with various tax policies enforced across government levels.

There is also precedence of tax decentralization with non-government players in Ancient Egypt, Greece, Rome and the Islamic Empire of the Caliphate. Tax farming was a method of distributed tax collection where private contractors would bid on government auctions to own the tax revenues within specified regions, and provide services to taxpayers in return. The process essentially capped government revenues, but provided significantly more wealth to contractors (the tax collectors) who would watch over taxpayers. It was believed that the Roman Republican leaders enjoyed this system as they had less control over revenues and subsequently less responsibility (and fault) over wealth redistribution.

Unfortunately, the implementation of tax farming led to contractors abusing citizens as they exploited them for revenues. They also colluded with governments to price gouge citizens and to limit their power of appeal. However it is conceivable that a tax farming system on a blockchain could be successful. With commitment to consensus, checks and balances via smart contract parameters and generally greater information sharing through digital, real-time markets; a more fruitful implementation could be possible where taxpayers are charged fairly.

Other unique taxation frameworks could also be devised in a decentralized manner. Harberger Taxes that were recently proposed in Radical Markets by Eric Posner and Glen Weyl, could enable greater allocative efficiency of property. Users could perpetually auction their properties priced relative to self-taxation, to ensure fair market rates and more equal property distribution.

A Tobin Tax or “Robin Hood Tax” could limit the impact that capital risk and financial meltdowns have on public good distribution. Capital investments or even cryptocurrencies could be taxed, where proceeds directly support public services. This idea was initially proposed by Nobel prize winner James Tobin in 1972, but again rose to fame following the 2008 economic crisis. Progressive taxation has also been successful in reducing poverty and bridging the wealth gap globally.

As the blockchain ecosystem matures with greater exploration into economic policies, we will realize the true capability of decentralized organization. The drive to reimagine wealth, property, ownership and security is widespread and decentralized autonomous taxation may be an effective method of aligning public interests in the long-term, in addition to existing government programs. It will be interesting to see how the ecosystem evolves and whether decentralized governance can surpass moral imperative into social enforcement.

Thank you to Kelvin FichterMark Beylin, Glen Weyl and Althea for contributing insights.

No copyright infringement is intended. Originally published on Token Daily.