Banknotes are useful. Not only do they provide their owner with a standard set of payments services, they also offer financial anonymity. This post introduces the idea of trying to price the anonymity component.
To help think about why we might want to price anonymous banknote usage, I’m going to make an analogy. Imagine Walmart sells special suits that allow people to become invisible. While most Walmart customers always pay for the goods they find in the aisles, a few try these invisible suits on, grab a bunch of stuff, and sneak out without paying. The product is weaponized and turned against its provider.
This same sort of weaponization characterizes the modern provision of banknotes. The government, like Walmart, provides citizens with a privacy-enhancing product: cash. Because its coins and banknotes don’t leave a paper trail, they act as a financial cloak. In the same way that an invisible suit can be used to evade Walmart’s checkout counter, a government-issued banknote can be turned against its provider by allowing users to avoid paying for the government services they have consumed.
Walmart may wish to do something about the weaponization of invisible suits, especially if the costs imposed by abusers of suits begin to exceed the amount of income the company gets from buyers of invisible suits. One option Walmart has is to stop selling the product. No one would fault them for putting an end to an unprofitable business line. Invisible-suit aficionados could just shop elsewhere.
But what if Walmart is society’s only provider of invisibility? This complicates things. While a few bad apples regularly abuse Walmart’s invisible suits by using them to steal, many others use the suits in legitimate ways. So while a decision to stop selling invisible suits might improve Walmart’s finances, it might also make society worse off.
This same tension crops up in the debate over the future of cash. A ban on cash would help reduce tax evasion and improve government finances. But since banknotes are the only anonymous financial product, and no other entity is permitted to provide banknotes, a ban would put an immediate end to financial privacy. Because privacy is something that regular folks value for licit reasons, their welfare would be reduced.
Say Walmart does the noble thing. It continues to stock invisible suits to meet the public’s demand for privacy. But the company still has costs it must meet, including wages, inventories, and rent, and with a steady loss of payments facilitated by the weaponization of invisible suits, that hurdle becomes much harder to clear. To plug deficits, Walmart may have to ask all its rule-abiding customers to pay a little bit more for their purchases by raising all of prices by a little bit.
But an across-the-board price increase hardly seems fair. Those abiding by Walmart’s rules are being asked to make up for a shortfall that is entirely the fault of suit-stealing rule breakers. Honest shoppers who don’t generally like to use invisible suits will be particularly furious — and who can blame them? They are being asked to pay more for the goods they hold dear in order to support the use of a single product they never cared for much anyway.
This same lack of fairness plagues modern tax systems. The government needs to fund (via taxes) the services it provides, but the presence of cash is weaponized against the system by tax cheats. The funding gap that emerges must be made up for by all of the remaining citizens — the non-cheaters. So taxes, or the price of government services, will be higher in the presence of cash than in a world without cash. Non-cheaters, particularly those who don’t use cash, will feel betrayed because they must pay higher taxes to support the ongoing provision of a product they don’t necessarily value.
Walmart may have a better option. Instead of increasing the price of all goods to make up for the behavior of a few invisible-suit users, it can just raise the price of suits high enough to make up for the shortfall. So customers who like invisibility end up bearing the costs imposed by thieves who weaponize suits. This targeted approach seems like a fairer path for Walmart to take. It releases a large chunk of its customer base from the obligation of offsetting the invisibility-induced shortfall while still giving those who value the privacy provided by invisible suits the option of buying them.
If setting a higher price for invisibility is the best option for Walmart, what about modern banknote-providing governments? In the same way that Walmart increases the price of invisible suits to offset the shortfall created by those who weaponize them, a government can introduce a levy on cash users. Rather than placing this levy on all banknote denominations, it might target high-denomination banknotes instead. The idea is that bulky $1s and €5s may be less useful in large-scale tax evasion than $100s and €200s.
By setting a levy or negative interest rate of 5 to 10 percent per year on high-denomination notes (there are various ways to do this), the government would be able to earn a large-enough stream of revenue to help offset the shortfall created by cash-using tax evaders. The effect would be a lower tax bill for all non-cheaters, both for those who generally do not use cash and those who use only small-denomination notes ($1 and €5s). In effect, the anonymity provided by $100s and €200s would now be directly paid for by the users of those $100s and €200s. Unlike an all-out ban on banknotes, financial anonymity would still be provided.
I think it makes sense for the Walmart in our thought experiment to give anonymity pricing a shot. Maybe governments should entertain the idea, too.
[This post was originally published at the Sound Money Project. I've modified it slightly for clarity.]
One thing not mentioned, and probably offtopic for this post, is the finality of a cash transaction.
ReplyDeleteWith credit cards, bank transfers and such the receipiant can never be sure that the money is not yanked back.
This is why certain construction constructors insist on cash payments. Heck, there is a practice called cashgating. Basically the buyer of the contractors service and the contractor meet in an bank branch. The buyer withdraws as much cash that the branch has at hand and allows for individual withdrawal. Hands it to the contractor, which gives an reciept in turn and the immediately deposits the cash into the contractors account. This might have to happen a few times as the cash supply at the branch might be limited. This way the bank is not an involved intermediatary in the transaction and can not reverse it like if a cheque was used (even a cashier cheque iirc).
Two issues with putting leavy or negative interest rate on high denomination bank notes:
ReplyDelete1. Tax evaders and such will use highest denomation bank notes that are not taxed in this manner. Say 50$ or 50€. If they want to reduce the bulk a bit they can vaccum pack a stack of say 100 bills. That reduces thickness about ⅕ to ⅓. Banks already do this btw.
2. Inflation makes the low denomination bank notes less and less practical to use generally making this in effect a defacto ban on cash. Which can evoke scenes like when bricks of Weimark banknotes were needed to buy a loaf of bread, specially during long downtimes of credit/debit card transaction processing networks.
"Tax evaders and such will use highest denomation bank notes that are not taxed in this manner. Say 50$ or 50€. "
DeleteYes, they will. But your missing the initial effect of taxing large denomination notes: it increases the cost of criminality and deters marginal bad actors from entering or staying in the market. So it is crime-reducing. Riskier bad actors will shift to lower-value notes and use costlier techniques (like vacuum packing), but that is evidence that the policy is effective, not that it isn't working.
1. is a hassle and does not scale nicely, which is providing some friction, which is the point of the tax.
Delete2. is trivially solved by inflation-linking the cut off point (make the smallest high denomination tax free when its value has declined too much).
@JP Koning: The anon forgot to point out that currently _nobody_ uses higher denomation bills than 50$ or 50€ as no one, merchant or otherwise, wants the hassle of trying to change an 100$ or 100€ bill (and a 500€ bills are out of the question).
DeleteRegarding the expense of vacuum packing a stack of bills: a good normal vacuum cleaner and a 20$ vacuum packing kit is all that is needed.
@Anon:
> 2. is trivially solved by inflation-linking the cut off point (make the smallest high denomination tax free when its value has declined too much).
That inflation-linking will either be left out entirely or blatantly ignored.
"Regarding the expense of vacuum packing a stack of bills: a good normal vacuum cleaner and a 20$ vacuum packing kit is all that is needed."
DeleteRight, but there's not just the initial investment but all the extra labor that goes into it the process of sealing and unsealing. Extra counting costs too, because $20s take more time to count than $50s. Even after vacuum packing, blocks of $20s will likely be a bit more bulky than an equivalent high denomination block, necessitating higher storage and handling costs. As the other anon said, all of these additional frictions are the exact point of the tax.
India did that by removing large bank notes in Modi's previous term. While it lead to the increase in usage of electronic money, there has been no evidence of it increasing transparency or reducing illicit cash. Just recently, Adani has been named by SEC in bribery case.
ReplyDeleteHow much do non-criminals actually care about privacy? The decline of cash suggests very little. This natural experiment suggests little inclination to pay for privacy.
ReplyDeletehttps://blogs.lse.ac.uk/businessreview/2024/01/02/what-londons-oyster-cards-reveal-about-central-bank-digital-currencies/
That's a great point. Payments nerds like me care about privacy, and in surveys people report that they care about privacy, but in practice they don't seem to put much value on it.
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