Hal Finney put out an excellent posting on why digicash and such are not likely to undercut the tax system. While a lot of what he says is valid, I would like to throw in another data point. You see, my wife is Italian, and I've spent quite a bit of time hanging out with the in-laws, seeing how they live and how their society works. Italy's underground economy is estimated at being 30% or more of the total GDP. It is a very cash-based economy, obviously. It is also a country where, IMHO, standards for honesty are lower than in the US and a certain amount of cleverness in avoiding things like taxes earns respect. Any Italian will tell you with pride that Italians do not follow rules. Italian merchants are required by law to produce receipts for every transaction. In fact, you as a customer may be required to produce the receipt on demand and will be fined if you do not have it. Nonetheless, if you do not insist on a receipt for many purchases -- even for very expensive things -- it has a good chance of not being produced. If you do insist, the price may suddenly increase. Tax evasion at the retail level is widespread.
Suppose I walk into IBM today and offer to go to work as a programmer, for 10% less than they would normally pay me, as long as they pay me "off the books", and pass on to me in cash the amount they would normally have to pay to the government in payroll taxes. Sounds like a win-win situation, right? Both IBM and I save money. But naturally IBM won't agree to this.
The only taxes that are sure to be paid are wage taxes for normal employees. Right? Well...for normal work, yes. My brother-in-law works in a furniture factory that, like all the rest of them, does a lot of its production off the books. As a result, much of his work is off the books too. This is how Italians make ends meet in a country with (relative to us) low salaries and high prices. There is a word for it -- arrangarsi -- "to arrange oneself". Tax evasion at the manufacturing/wholesale levels is widespread. The official response to this is a good study in governmental desperation. Customers are fined for leaving businesses without a receipt. Your car may be stopped and searched for undocumented merchandise at any time. Imputed income taxes for self-employed people are at ridiculous levels (i.e. a large degree of evasion is assumed). Taxes are levied on everything (car radios, the width of your driveway, electric lighters for gas stoves). I am told that Italians were, at one time, forbidden to possess foreign bank accounts; this rule is not sustainable under the European Community, of course. And none of the above is working very well. As long as Italians believe that it is their right to skip out on their taxes (while, of course, demanding extensive benefits from the government) the situation will continue. I guess my point here is that one should not be too quick to assume that this sort of situation could not arise in the US. Cryptography and digital cash may not, in and of themselves, bring down the tax system. But if Americans decide that they have had enough of it, severe problems could arise with or without such tools; they would only make it easier. Tax evasion rates are low (relatively) in the US because people here are more inclined to follow the rules, and because most people seem to believe that you can't get something for nothing. That is a much more powerful force than any repressive governmental action.