Wednesday, April 17, 2019


The U.S. $10,000 was available till Nixon nixed it in 1969

For the last few years the conversation about cash has been dominated by Ken Rogoff's proposal to remove high-denomination banknotes. In an effort to broaden the discussion, last year I wrote an essay for Cato Unbound about introducing a new U.S. supernote. The value of the current highest denomination note--the $100 bill--has deteriorated over the decades thanks to inflation. Is it time to restore the purchasing power of U.S. cash by bringing out a $1,000 note?

In the same essay I also floated the idea of taxing the supernote. Why a tax? A new $1,000 bill could be used for both good and nefarious purposes. Given that nefarious supernote usage (tax evasion and crime) could impose costs on society, a tax would make up for this by transferring wealth from note users to the rest of us. (I also blogged about the idea of taxing cash here and here). 

Josh Hendrickson, Will Luther, and Jamie McAndrews all had responses. Do read them, as they give a good sense of all the various nuances and complications involved in issuing a supernote and taxing it.


Say we introduce a new supernote worth $1,000. What would Walter, a seasoned drug dealer, think about this new policy? Let's walk through the day-to-day costs that Walter absorbs as an illicit cash user.

Walter makes large value payments using banknotes. He also stores plenty of the stuff. A million dollars worth of $100 notes (i.e. 10,000 notes) takes up a lot of space. But one thousand $1000 bills can be packed into a container a tenth the size. This will make Walter's business much easier to expedite. His costs of counting, transporting, storing, and sorting notes will all drop significantly.

The risk of detection will also be much lower with supernotes. Hiding twenty supernotes in a car is a lot easier than hiding two-hundred $100 notes. Detection by authorities imposes costs on Walter and his associates. Banknotes can be seized under civil asset forfeiture laws. In many cases the police can seize cash on mere suspicion of wrongdoing--they don't even have to charge the owner with a crime.

Example of an asset forfeiture case involving cash [source]

These seizures can be contested by Walter and his associates, but this will involve significant time and legal expenses. There are also non-pecuniary losses associated with detection. If Walter or one of his associates is pulled over for speeding and the cops find a bag full of $100 notes in his car trunk, that may provide law enforcement with information and insight into his network.

Finally, Walter also incurs a "tax" on his cash holdings. Specifically, his cash does not earn interest. If Walter regularly stores $100,000 in cash, and the interest rate is 3%, he is effectively forfeiting around $3,000/year. This loss is the same whether Walter holds his stash in $100 notes or supernotes. Walter's $3000/year loss goes directly to the public. He is providing the rest of us with an interest-free loan, or a subsidy.

Weaving this all together, from Walter's perspective the new supernote is a great product. It reduces his storage & handling costs (S) as well as any costs arising from detection (D), and does so without increasing his taxes (T).

Civil society isn't quite as well off with a supernote. We've provided Walter with a superior means of avoiding detection. Not only does this mean that we've increased the odds of Walter staying out of jail. We've also reduced asset forfeiture revenues. Since law enforcement agencies uses forfeitures to fund their operations, any diminution in this flow means that the rest of us will have to pay higher taxes to compensate.


Why don't we strike a deal with Walter? If supernotes allow him to enjoy lower S and D, why don't we ask for higher T in compensation? Setting a higher T involves an increase in the tax rate on supernotes relative to $100 notes.

One way to do this is to make the supernote depreciate a bit each day. The central bank will buy the note back today for $1000, but tomorrow it will only buy it back at $999.95. This constitutes a 5¢/day transfer from Walter to the public. At a yearly interest rate of 3%, he also loses around 5¢/day in forgone interest. This combination of a capital loss and forgone interest comprise the supernote tax.

Now when Walter and his colleagues switch from using the $100 bill to the supernote, society's decline in forfeiture income is compensated by higher tax income. Even with the higher tax, Walter prefers the supernote to the $100 because he saves enough on S and D to make it worth his while. So everyone wins if we issue a supernote.

Or as Hendrikson says in his response essay:
"the introduction of the supernote is in this instance welfare-improving (given the premise that illegal trade creates a social cost) because it allows policymakers to engineer a transfer from criminals to law-abiding citizens that would not be available otherwise."

There may be some additional improvements in efficiency to be gained by replacing a bad tax--asset forfeiture--with a good one. Having the police directly raise funds by confiscating people's property is ripe for abuse.
By contrast, a supernote tax is automatic, predictable, transparent, and easier to collect.


A supernote would provide at least some benefit to non-criminals. Say that Sarah wants to sell her car for $8000. She may be wary of accepting a check from the buyer, Todd, who she doesn't know. If she provides the car to Todd but his check bounces, then she's out of hand. Cash is a simple way to solve this problem. The moment that cash passes hands from Todd to Sarah, the payment is 100% certain.

Without a supernote, Todd will have to pay for the $8000 car with eighty $100s. Wouldn't it be more cost effective for him to make the payment with just eight $1000s? Less counting is required and the bills easily slip into a wallet. So S is reduced. (Detection, or D, is not a cost that licit users need worry about.)

Unfortunately the imposition of a tax will reduce the supernote's potential for improving the lives of non-criminals like Sarah and Todd. Since the tax raises the cost of the supernote relative to alternatives like the $100 note, many people who would otherwise have consumed the supernote just won't bother. Put differently, the  consumer surplus (for licit users) that is created by the introduction of a taxed supernote will be small than if the supernote was untaxed.

If the tax is set quite high, then usage of supernotes may be entirely confined to criminals. This the sort of monetary future that David Birch would probably say was first described by novelist William Gibson in Count Zero. Cash still exists, but it will have disappeared from polite society.


A taxed supernote is a neat idea, but does it qualify as a "fancy monetary standard" i.e too abstract and academic to inspire confidence? "Fancy" is the word that Irving Fisher's critics used to denigrate his early ideas about price targeting.

Admittedly a taxed supernote doesn't present a very clean user interface. Having a round face value is one of the conveniences of a note. This feature ensures that it can be easily divided into smaller amounts. But the supernote tax means that the face value of the note will very quickly fall to some inconvenient number like $999.33. As McAndrews points out
"...the differential rates of exchange among the different denominations of notes is an inconvenience. The cost of all those calculations required to make change and set different prices based on which note a customer offers must be counted against whatever benefit a tax might achieve."
It might be possible to avoid the rounding problem by finding a different means for assessing the tax. In his paper Taxing Cash, Ilan Benshalom describes a withdrawal tax. This tax would be assessed whenever money is taken out of an ATM or bank teller. However, supernotes will probably circulate for long periods of time without every being deposited, which means the withdrawal tax will rarely be activated.

For now, taxed supernotes are science fiction. But who knows? Irving Fisher's fancy monetary standard was science fiction for decades, but it has slowly become the standard way of doing monetary policy these days.

1 comment:

  1. MMMMM??? Somehow the dealer has to convert small bills into the $1000 bills. How does he do this without folks getting interested in his business? The vending machine operators have the same problem converting bags of coins/small bills into bank deposits.