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Paper money is under fire

Ending large bills to undercut illicit activity is a popular notion, but at what cost?
Tuesday, July 24, 2018 - 1:56pm
Lori Johnston

The saying goes that cash is king, but in today’s economy, is it really? Popular proposals for eliminating large bills say it could reduce tax evasion and undesirable trade in the underground economy, like drug trafficking.

But surprising preliminary findings by Terry College of Business economics professor William D. Lastrapes show that social welfare could decline when people can’t pay with $50 and $100 bills.

“Getting rid of cash overall might have more costs than benefits, and the purpose of any policy should be to increase our well-being, not reduce it,” he said.

The research paper, which appeared this summer in the Cato Journal, takes a preliminary step in estimating whether proposals to eliminate the two largest denominations of dollar bills are worthwhile.

It’s a well-established fact that many people try to evade taxes by using cash because it’s less traceable than cards or checks, Lastrapes said. But he also was motivated by claims that most $100s, and even $50s, are used in the underground economy for many other illicit purposes.

“One of the arguments for eliminating cash is that it’s going to help on both those fronts,” he said. “It’s going to make tax evasion costlier and more difficult, and it’s also going to reduce the underground economy.”

Think about meth kingpin Walter White in AMC’s “Breaking Bad” and scenes showing loads of cash collected in his crawl space, for example. If you eliminate cash, it’s more costly and risky for him to do business.

But Lastrapes said a policy to do away with large bills would also have subtle costs and unintended consequences for people who follow the law. He used a macroeconomic model to analyze what would happen to the economy if the government eliminated cash for the purposes of reducing tax evasion.

“The aim is to think about this in terms that are quantitative. You can’t just say it’s going to make it more difficult to evade taxes. How costly will it be, and how much do people lose by not using cash?” he said.

His analysis found that suppressing big bills reduced tax evasion and increased government spending on valuable infrastructure and public goods, which is a good thing. But because people paid more taxes, they worked and invested less, which caused total economic production in the model to fall.

“And simulating the model showed that, overall, this cost in lost output and consumption exceeded the benefits of less tax evasion, making people worse off from getting rid of cash,” he said.

The paper lays the groundwork for further examination, especially with the interest in cryptocurrencies, such as Bitcoin, as alternatives to currency. But the model’s main strength, he added, is that it showed the effects such proposals would have on social welfare could reliably be quantified.

“As economists, we try to be as precise as possible. Can we put some numbers to the costs and benefits? If so, then you can make better policy, and that’s what we’re trying to do,” he said.

This summer, Lastrapes is co-authoring a paper that extends the model to continue his research.

“Paper currency is a topic that appeals not only to economists in different fields but to the public as well, because it affects their everyday lives,” he said.

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