Scott Sumner  

Tax dodging and currency

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David Henderson has a recent post discussing the costs and benefits of tax avoidance. Here I'll discuss a similar issue, the pros and cons of hand-to-hand currency.

In an earlier post I argued that eliminating currency would solve the "zero bound problem" in interest rates, but that it was a bad idea for libertarian reasons. There are much more cost effective ways to address the zero bound problem, such as level targeting of prices or NGDP. (The ECB desperately needs to switch to level targeting along a 1.9% inflation track.)

It's widely known that currency facilitates transactions in the underground economy, and hence that measured GDP in countries like Italy is far below actual GDP. I see much less discussion of the impact on actual GDP.

College professors who advocate the elimination of currency are often unaware of how important currency is for those with low incomes, many of who lack bank accounts. For instance, consider someone getting government benefits that are conditional on income (food stamps, EITC, disability, welfare, Medicaid, etc.) This group often faces relatively high implicit marginal tax rates. However currency allows them to supplement their meager benefits with additional earned income, perhaps doing home repair for neighbors, or working as a nanny. Lots of those jobs are paid in cash. If we eliminate physical cash then all transactions will be easily traceable by the government. Obviously that raises privacy concerns, but it also would lead to a decrease in actual GDP. That's bad for two reasons; low-income people would see reduced incomes (increasing inequality), and the rest of us will be denied the services that they might have produced in the underground economy. Economists who advocate the elimination of currency need to consider those side effects.


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CATEGORIES: Labor Market , Money




COMMENTS (6 to date)
Pemakin writes:

I think you are right about currency, the underground economy and low income people. But it should also be recognized the UE and cash undermine incentives given the income thresholds built into safety net programs. Marginal "tax" rates in the 70%s (see Mulligan) versus 0% on UE earnings make for no marginal incentive to work for reported income.

Scott Sumner writes:

Pemakin, I agree, and favor redesigning these programs. I'd like to see the EITC program changed to an hourly subsidy, so you get more subsidy the more hours you work.

Bill Woolsey writes:

Private redeemable hand-to-hand currency would allow poor people to "work under the table." Since such currency would not serve as medium of account, it would create no zero nominal bound barrier.

Of course, if other interest rates are too low, issuing hand-to-hand currency won't be profitable. If no one will issue it, then it won't be there for anyone to benefit.

Abolishing currency in order to deal with situations where the market clearing levels for some interest rates is negative sometimes, seems like a bad idea. A permanent burden to solve an occasional problem.

On the other hand, permanently raising the inflation rate (or growth rate of nominal GDP) for that same reason also seems like a bad idea. We must put up with high inflation always to solve an occasional problem.

No longer using currency as medium of account, but rather treating it as just one subsidiary financial instrument is a much better approach.

Yes, the government could issue it and even continue to monopolize it. As Kimball points out, all that is needed it to vary the exchange rate of currency during the special periods with the implicit yield is negative, and there is no zero nominal bound.

Scott Sumner writes:

Bill, Those are good points, but I don't think we need to divorce the medium of account and hand-to-hand currency. It makes things too confusing. The zero bound problem can be cured with NGDPLT.

Floccina writes:

Just yesterday I had an unemployed friend detail my truck for $60. He is collecting unemployed but he needed money and I had needed to clean my car for a long time but I was not getting to it. We are both better off for the transaction. I am betting that he does not report the income (where/how could he?).

Scott Sumner writes:

Floccina, I don't think you'll find anyone to take that bet with you. :)

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