The Kay Tax

Richard Kay - 1998

How a small tax change
enabling greater use of
account-based community currencies
could initiate economic transformation.


0. Contents

  1. Abstract
  2. Introduction: chaordic systems and global transformation
  3. Social and economic principles behind taxation
  4. Current taxation practice in relation to economic change
  5. Community currencies and current tax regulations
  6. Collecting and spending taxes using community currencies
  7. The transition to a new economy
  8. Wither the state?

1. Abstract

This paper was written to support a workshop delivered at the TOES 98 conference held in Birmingham, UK from 15-17 May 1998. It explores the background, potential consequences and feasibility of a proposal for a minor change in tax law affecting taxable income, sales and profits earned using account-based community currencies such as LETS and hour exchanges etc. It assumes the reader is familiar with the concepts and operations of account-based community currencies such as LETS, WIR and time dollars. For those unfamiliar with these some introductory information and references are given in appendix A.

2. Introduction: chaordic systems and global transformation

The term "chaord" is a recent construct deriving from the roots chaos and order. It is used in connection with systems which display complexity combined with the ability to retain and refine information to enable adaptive and evolutionary change. Clearly to do this a system needs a degree of order and organisation and parts of such a system need sufficient autonomy, freedom and flexibility to be able to innovate while being sufficiently connected to the rest of the system to prevent its disintegration.

The concept is of a fluid organisation which rests at the edges of chaos, at some distance from the boiling point at which disintegration would occur whilst far from the point of freezing and rigidity. Such a system will tend to use the relative autonomy of its constituent parts to process information in parallel which, in a more rigid form of organisation, would be bottlenecked by some form of centralised sequential control.

Examples of systems which display these properties include the human brain, the global economy, the telephone network, the Internet and the Visa network. ( The term "chaord" was coined in connection with the organisation of the latter network). The global weather system considered as a separate entity demonstrates complexity, certain degrees of order and chaos but does not retain or refine information. The Gaia hypothesis of James Lovelock, however, describes the weather system as part of a larger ecological and evolutionary system which does retain and refine information.

Chaordic systems are based on rules which may be refined in order to develop the system. The economic system has various rules based on fundamental principles, for example the common law of contract, which have over time been modified, e.g. by making certain kinds of contract illegal or not legally enforceable. This system also contains a rule which was expedient when it was established yet which is becoming less so and is not based on any fundamental underlying principle, i.e. the requirement to pay taxes using legal tender. This rule bottlenecks the processing capacity of national economies through the need for centralised control over a single currency which occupies a monopoly position. It restricts the budgetary tax and expenditure control functions of state in a similar manner. Modifying this rule in order to involve the state in the decentralised and parallel use of very many smaller community currencies is a necessary step in the development of the part which these are! able to play.

Most minor rule changes will not exercise a major influence over the general functioning of the system of which they are a part. However if an adaptive rule-based system is functioning at the edges of chaos it follows that there will exist some minor rule changes which can have a global and transforming influence over the system as a whole.

This paper is concerned with the possibilities for a such a rule change which would initially affect a very small part of the global economy, yet which has the potential to transform it.

3. Social and economic principles behind taxation

We might consider that the state was initially founded on the basis that "might is right". Once competition for resources became an issue human society became organised around the defence of territorial rights through the tribal system. Certainly the introduction of written law around 6000 years ago enabled a major advance in the complexity of social organisation. Before this we can assume that warlords and tribal chieftains would arbitrarily have requisitioned whatever they wanted from their subjects for their own purposes; after this citizens had rights to retain what was theirs from what they produced after paying whatever taxes were due for the purposes of external and internal security.

In more modern times the need to provide for an educated population combined with efforts to involve the state in the principle and practice of treating one's neighbour as one would like to be treated has also resulted in various extensions of state provision funded through taxation. While not everyone has accepted the argument that the state should be so involved, given that those in need of healthcare or education are least able to pay for such, for the purposes of this paper it is assumed that some form of collective provision will be made in a civilised society.

Most would agree that taxation should be based on the ability to pay. But this is compromised in practice by the ability of the state to collect taxes and the influence which the large trans- national corporations exert through their ability to move their investments to where subsidies are highest, taxes are the lowest and where social and environmental regulations displace the costs of their activities onto those who can least afford them.

4. Current taxation practice in relation to economic change

Taxation needs a base on which it can be assessed. Various bases have been used historically, for example the Doomsday Book was used to record the value of assets throughout England in the 11th century for this purpose. Whatever base is used for taxation, the taxpayer will strive to minimise this base. For example when taxes were based on the number of windows, many windows (particularly those allowing light into servants quarters) were blocked up . Thus a proposal to change the base on which taxes are collected requires consideration in advance of the effects on this base.

The taxation system of industrial society being based mainly on income and profits depends on certain assumptions which became relevant during the Industrial Revolution, including:

  1. Most people are in regular paid employment working mainly for a single employer.
  2. People are less likely to hinder the collection of taxes when these are deducted from payroll by their employers than when collected from them directly.
  3. Relatively few people work for more than one employer or are employers while the latter and the self employed earn most of their income and profits through a regular line of business.
  4. Most economic activity is contained within national boundaries and cannot escape national taxation by being conducted offshore.
  5. For reasons of efficiency most monetary transactions involve the use of anonymous tokens such as notes and coin, which can be accounted only to a limited extent in aggregate.
The difficulties caused to the system of taxation within post-industrial societies by the fact that assumptions a. c. and d. are becoming less valid are compounded by the fact that in democracies people will generally vote for politicians who promise to spend high and tax low. The fact that this can only be achieved to an extent financed by printing more money and borrowing at interest against the future contributes towards a growing and general crisis of confidence in political and economic institutions.

However financial innovations including credit cards, digital cash and LETS also call assumption (e.) into question, which suggests possibilities for different bases for taxation from those of profit, income, sales and value added, namely transactions and turnover.

How would a general flight from taxes based on transactions and turnover direct the economy towards more sustainable, cooperative and equitable patterns of activity ? I will explore this question in more detail further on, but it essentially depends upon how this flight could be directed to encourage activity to take place at the most local and small scale consistent with other reasonable individual, social and economic objectives.

5. Community currencies and current tax regulations

Much activity in many community currencies takes place below the level at which the tax authorities are interested. Unless what is being bought and sold constitutes a regular line of business the income and profit derived is not generally taxable. However those who conduct a regular trade through use of a community currency such as LETS are expected to pay taxes using legal tender based on the nominal value of the community currency earned, profited by or value added.

Having to pay taxes in conventional money on business transacted using a community money acts as a disincentive to maximise such income while forcing those using such to earn sufficient to pay taxes and other expenses which can only be paid using conventional money. This works to limit the growth and possibilities for using community currencies perhaps more than any other factor. Employees of those engaged in a regular business earning any significant fraction of sales income using a community currency will be reluctant to be paid even in part using this money when the effect of taxing this in legal tender is to reduce the conventional money available to them.

Because the state avoids using community currencies in its taxing and spending functions a number of consequences arise:

  1. Businesses are less able to participate in using community currencies and
  2. The use of community currency is restricted to:
    1. exchanges between businesses (e.g. WIR and business barter exchanges)
    2. exchanges of occasional social favours between private individuals (e.g. LETS)
    3. the accounting of what would otherwise be unpaid and untaxed voluntary work where some future expectation of reward can be anticipated (e.g. Time Dollars and LETShares).
The potential of community currencies enabling economic activity to be conducted in a more socially and environmentally defensible direction is well documented. Logically this requires state involvement by raising and spending taxes using community currencies in support of normal state-financed activity; this will then increase business sector participation.

6. Collecting and spending taxes using community currencies

To make it possible for taxes to be payable in local money on income or profits involving local money two practical issues need to be addressed:

  1. Government in its present day structure is not well placed to make decisions about how taxes raised using a community currency involving say less than 5000 people could most effectively be spent, given lack of knowledge about detailed needs or available value for money at this level. These decisions will need to be delegated to the community or taxpayer which is where the learning process involving people taking more responsibility for this must start.
  2. Current methods of assessing income and profits for tax purposes are not relevant to such a small scale because the complexity of administration would be onerous and the cost would exceed the benefit. Basing taxes on turnover will be simple enough to be feasible. This reduces the initial effective scope of this proposal to account-based community currencies alone.
Clearly an exemption from conventional taxation (as would otherwise be required in legal tender) for our purposes depends on adequate disclosure - which places an onus on the community operating its own currency applying for this exemption to demonstrate that it qualifies. This seems easiest to achieve by showing through independent audit of accounts that a sufficient proportion of the turnover of the entire community money system is being directed towards projects such as schools and clinics etc. which would normally attract state support. The community applying for this exemption would need to decide how it raises and allocates this proportion. This could be either through some collective process or by individual taxpayers allocating taxes amongst eligible projects.

What should this proportion be ? For a small network in which most transactions are likely to be of an occasional "social favour" nature little conventional tax would be due and the turnover percentage for the proposed tax should likewise be small.

Example 1: Consider a community currency with a combined turnover of less than 100,000 UK pounds equivalent. If it was estimated that 20% (0.2) of the turnover of currencies in this band would, under conventional rules, be taxable at an average rate of 25% (0.25) it would then be reasonable to band currencies of this type at a Kay Tax rate of 5% (0.2 X 0.25 = 0.05 = 5%) of total turnover.

Example 2: Consider a currency with a combined turnover of between 100,000 and a million pounds equivalent. If it was estimated that 40% (0.4) of the turnover of currencies within this band would, under conventional rules, be taxable at an average rate of 25% (0.25) it would be reasonable to band currencies of this type at a Kay Tax rate of 10% (0.4 X 0.25 = 0.1 = 10%).

7. The transition to a new economy

There are no technical reasons why most economic activity could not be transacted using interest-free Kay Tax carrying currencies used by perhaps 10 million or fewer people. The difficulties seem more likely to be those related to getting enough people to understand the benefits and availability of these new economic possibilities and being able to minimise opposition from the many and various interests vested in the conventional system. Whether this can be done depends upon sufficient will being mustered to bring about the relatively small initial rule change needed to make this transition to a new economy possible.

To encourage people to use the most local possible currencies - to gain the greatest social and environmental benefits - the percentage tax required should increase with increasing turnover for the entire currency system. To effect simpler administration and auditing these total currency turnovers should be banded. This also means that community currencies operating on a scale sufficient to provide efficient economic specialisation and economies of scale will also be able to provide more substantial support for publicly funded healthcare, education and policing etc.

One outcome of this is that people will inevitably find it to be in their best interests to use more than one currency. In practice intelligent networked systems which optimise and automate transactions and exchanges between currencies will make it possible for those who prefer to think and make decisions only in terms of one currency to do just that to the extent that most people will not even need to know which micro and mini-currencies they are in fact using any more than they need to know how a telephone exchange works to make a call; they will develop a preference to use smaller currencies where possible and within- currency transactions to foreign-exchange mediated transactions entirely through the price differences they see in the shops and active catalogues etc.

Those involved in the administration of the proposed tax will have very limited time, resources and information at their disposal so they will need to keep it simple. By basing taxes on currency turnover as a whole it will therefore become much more difficult to justify why some types of transaction using the same qualifying currency should be taxed less causing others using the same currency to be taxed more. The most likely arrangement will be that all transactions will be taxed at the percentage required for the currency as a whole.

The initial legislation needed to make this all possible is more likely to succeed if implemented first at the smaller end of the community money scale because this is then less likely to be opposed by the many and various interests vested in the conventional system. Opposition to small-scale introduction will make a public debate more likely which is to be welcomed given that this will enable most who follow this debate to see the benefits of this proposal. Once this process demonstrates its usefulness, however, the scale at which community currencies can be operated within the context of this proposed new tax method can only increase through pressures to lift the glass ceiling. As the higher rate taxes raised on higher turnover community currencies come in, this new source of public finance will begin significantly to replace that raised through conventional taxes.

Initially this proposal will affect currencies mainly intended for current account trading. However as the scale increases some use of these currencies for savings and investments becomes inevitable. As all transactions in affected currencies will carry some level of tax the buying and selling of investments and transactions involving the exchange of currencies will themselves be taxed. Consequently this will dampen speculative trading in investment and foreign exchange markets whose operators will then be forced to consider genuine end-user driven requirements in preference to short-term speculative considerations.

The overall economic and environmental effects of this change will be significant. Investors will be attracted to invest in smaller enterprises with more satisfactory long-term prospects in preference to globalised corporate monopolies based on short- term profitability and the ability to manipulate governments and markets. Consequently there will be fewer layers of management, products will need to be made to last and large-scale manufacturing will become more expensive. Additionally recycling and particularly reuse of packaging etc. will become cheaper.

The transaction costs of trading over long distances might reduce but will not kill off the high-technology industries requiring global scale economies such as oil, semiconductors, air transport etc. but will make their products and services more expensive in comparison with other things which can be manufactured, grown and serviced more locally. (This proposal might, in consideration of the fact that it requires the implementation of an intelligent electronic network, be considered to require the continuing development of the semiconductor industry. However in this industry costs are currently falling by approximately 50% every 2 years and can be expected to do so for many years to come. The rate of increase of prices of globally traded goods relative to prices of items produced and consumed locally likely to be caused by the phased introduction of the Kay Tax can be expected to be less than the rate by which semiconductor production costs are falling. This proposal might the! refore slow the rate of growth of this industry but is unlikely to cause it to decline.)

This will require a shift towards methods which involve less use of imported and fossil-fuel based energy, particularly in transport and buildings. Agricultural products which come from far away will become less competitive compared to local produce. Increased transaction and transport costs in farming will result in smaller scale production. This will increase biodiversity and the attractiveness of organic methods.

The transition to general use of multiple, small, community- based, interest-free currencies will also have a significant effect on the jobs market. Consider that conventional money is based on issue by governments effectively bankrupted by the electoral expediency of low-tax, high-spend deficit finance. To retain any value conventional money must therefore retain a monopoly position and be kept in artificially scarce supply through interest rate policy. This results in persistent underemployment particularly where the skills required are not specialised and in high demand.

When there are very many community currencies carrying zero interest, cost-of service and bad-debit insurance charges with lower taxes for the smaller and more local transactions, the effect on job markets will be:

  1. higher relative demand within the local economy for less specialised skills suited to smaller scale activity and
  2. more specialised skills will be attracted to the more regional markets where larger currencies operate resulting in greater scale efficiencies and more variety of goods and services being sold.

8. Wither the state?

Marx predicted the eventual withering away of the state. As this proposal suggests some reduction in its functions I will first describe the parts not directly affected. There will still be a need for laws to be passed and enforced, legal cases to be heard, public finances audited (through whichever currencies these are raised) and managers of tax-spending authorities to be hired and fired. Also if an imminent and permanent outbreak of world peace is considered to be unlikely this will retain for some time a residual military function just in case.

But there will be an indirect downsizing effect on the judicial arm of state: Full employment, rooting community relationships through the local economy and an end to the extortion historically practised by the rich upon the poor by charging interest on money can be expected to eliminate much poverty- related crime. The downsizing effects will however be seen first on the executive arm of state which many believe to have become oversized in the last century or so. In this area the power to determine budgets for the various tax-spending authorities will be delegated to the taxpayers or collective bodies elected to decide how taxes collected using particular currencies are to be allocated. The executive will need to retain a residual control over the auditing of community currencies to ensure that the qualifying percentages of turnover are directed to appropriate tax spenders.

Delegating the power to divide the tax-cake between the various tax spenders both to the taxpayers and those to whom they individually elect to make these decisions for them will remove the electoral advantages to politicians of fiscal laxity and enable them to concentrate more of their energies on passing better laws and making better hiring and firing decisions. This will also require and produce a more politically mature electorate; voters who decide for themselves how the tax cake will be cut will no longer be able to blame their chosen representatives for the unfortunate and unalterable fact that resources for education, policing and caring for those in need will always be limited.

The outcome of this proposal represents a great cultural shift affecting many areas of life and a significant learning curve for all of us. How quickly this transition can be managed will be the responsibility of those we elect; they will have to decide the turnover limits and taxation rates for community currencies qualifying for the proposed exemption from conventional taxes and they will have to assess how soon these limits can be raised. It is also for each and every one of us to decide how long we can continue to tolerate the unjust, wasteful and self-destructive tendencies of the conventional economic system and how soon we need to start putting the political and monetary requirements for the transition to the new economics described in this paper into effect.

In conclusion the Kay Tax while initially representing a very small change in taxation rules can, when fully implemented, be expected to facilitate very significant change in many areas of economic, social and political life.


Appendix A. A brief introduction to community currencies

A community currency is a kind of money separate from conventional money which circulates more or less exclusively within a particular community with the currency system being owned and operated by and for that community.

This concept is perhaps best illustrated by example. Probably the largest community currency is the Swiss WIR system which started in the thirties and turns over more than 2.5 Billion Swiss Francs equivalent per annum (1993 figure). This is a double-entry, account-based, professionally-managed currency used by more than 76,000 participants (1993) within Switzerland. For details see: http://www.ex.ac.uk/~RDavies/arian/wir.html.

The business barter exchange is a kind of community currency in the sense that it provides a means of exchange between members of a particular community. These are not community currencies in the sense that these exchanges are owned and managed by (and for) their operators. However in the US these have been estimated to turn over several billions US dollar equivalent per annum. For information see: http://www.i-barter.com/.

Another example of a double-entry, account-based community currency is the LETSystem. There are believed to be several hundred similar systems in operation worldwide each turning over between a few hundred and 150,000 UK pounds equivalent per annum with between 20 and 1500 participants. Unlike WIR, LETS are managed by their users who have information about other users' balances and turnover, and can decide whether to buy from or sell to others based on their current level of credit or commitment. Like WIR this kind of money is backed by the business reputations of its issuers. This factor and the fact that money circulating within LETSystems is fully backed by issuers' commitments entered into to the community as a whole gives this kind of money its stability.

Users will have to pay the cost of account service by one means or another. In a LETS this is typically collected through a small fee in local money per statement and for clearing a cheque. To the extent that debits might go bad it is also in the interests of users to share the cost of writing these off, possibly through an annual renewal fee in local money which can be used to ensure that active accounts stay in balance.

It is not in the interests of those with the credibility to issue this kind of money for those in debit to pay interest, so those who can back this kind of money will generally prefer to participate in zero interest systems. For details of LETSystems see: http://www.gmlets.u-net.com/ and http://www.mailbase.ac.uk/lists/econ-lets.

A further kind of community currency is the Ithaca HOURS fiat paper currency used in Ithaca New York state. This has the advantage of not needing to account each transaction, but has to be issued conservatively in order to retain its value. The disadvantages of such unbacked currencies is that they retain value by being in short supply and could be destroyed very quickly by a drop in confidence given that their users are not obliged to use them. Nevertheless Paul Glover estimates that more than 2 million US dollar equivalent worth of business has been transacted using Ithaca HOURS since 1991. For details see: http://www.lightlink.com/ithacahours.


Appendix B. Further reading

The Chaordic Principle: mixing chaos and order to jumpstart the 21st century, Dee Hock.
Publisher: Bantam Doubleday Dell Publishing, ISBN: 0385482191 - Due out: May 98

The Chaordic Organisation: out of control and into order. http://www.newhorizons.org/ofc_21clidhock.html, also written by Dee Hock.

An exploration and discussion of future monetary possibilities including Bernard Lietaer's writings can be found at http://www.transaction.net/.

Short Circuit: Strengthening Local Economics for Security in an Unstable World, Richard Douthwaite.
Publisher: Green Books. ISBN 1 870098 64 1

Cities and the Wealth of Nations, Jane Jacobs.
Publisher: Penguin Books. ISBN 0-14-022677-X

Denationalisation of Money - The argument refined, F A Hayek.
Publisher: IEA. ISBN 0-255 36239-0


Appendix C. Copyright notice

© Richard Kay 1998

Permission is granted to copy this article electronically and distribute and print it on condition that it is made available to others complete and unmodified. Extracts from this article may also be quoted on condition that these correctly acknowledge authorship and clearly identify where a full copy can be obtained.