The Curse of Cash: Crime

Kenneth Rogoff is a well-known economist who has long had issues with paper money.  He has presented his case against the troublesome stuff in his recent book The Curse of Cash. 

Rogoff believes that paper money (cash) can and should be eliminated except for a few small denomination notes that would eventually be converted to coins.  He presents two arguments for why this step should be taken.  The first is related to the manner in which cash transactions facilitate a number of illegal activities.  Since cash transactions generally leave no record, tax evasion, unrecorded payments of wages to illegal aliens, large-scale criminal activities, and corruption of public officials are facilitated.

“….making it more difficult to engage in recurrent, large, and anonymous payments would likely have a significant impact on discouraging tax evasion and crime; even a relatively modest impact could potentially justify getting rid of most paper currency.”

His second argument is related to the low-interest-rate environment that developed countries have found themselves in after the Great Recession.  As interest rates have dropped to near zero, central banks have lost much of their ability to reinflate the economy with monetary policy.  A few have attempted to try small negative rates to address this.  Rogoff believes that setting negative rates will become more important as a tool for national banks, but in order to make it effective the alternative of moving investment into cash (a zero-rate instrument) must be eliminated.

“….as I have argued for some time, phasing out paper currency is arguably the simplest and most elegant approach to clearing the path for central banks to invoke unfettered negative interest rate policies should they bump up against the ‘zero lower bound’ on interest rates.  Treasury bills cannot fall much below zero, precisely because people always have the option of holding paper currency, which at least pays zero interest.”

Of interest here is the first issue and the details Rogoff provides about cash and how it is used in the United States and other developed countries.

The first thing to learn about cash is the amount that is in circulation in the economy.  One might think that all of the modern means for digital monetary transactions would have limited the demand for paper money.  Rogoff tells us that is far from being the case.

“Anyone who thinks that debit cards, cell phone payments, and virtual currencies are already burying cash could not be more wrong.  Demand for most advanced-country paper currency notes has been rising steadily for more than two decades.  Believe it or not, as of the end of 2015, $1.34 trillion worth of US currency was being held outside banks, or $4,200 floating around for every man, woman, and child in the United States.  The orders of magnitude for most advanced-country currencies is broadly similar.”

Not only is this an enormous amount of cash, it exists mostly in a form that would make it difficult to be used in most daily transactions.

“Incredibly, the vast bulk of this mass stash of cash is in high denomination notes, the kind most of us don’t carry in our purses and wallets, including the US $100 bill, the 500-euro note (about $570 at present), and the 1000-Swiss franc note (a little over $1000).  Almost 80% of the US currency supply is in $100 bills.  How many people have 34 of them in their purses, cookie jars, or cars, as each individual would need to account for his or her share?”

Those figures should arouse some suspicion that there is something not quite proper about how these bills are being used.  Apparently, little is known about where this money ends up after it is printed and how it used.  Rogoff had to expend considerable effort to arrive at some estimates—and estimates they were. 

Let us begin with the use of cash in what is referred to as the “underground economy.”

“The underground economy includes a huge range of blatantly illegal activities, for example, the drug trade, extortion, bribes, human trafficking, and money laundering, just to name a few.  But it also includes ordinary people—a great many of them—who use cash on occasion, say, when hiring babysitters or painters, to get a lower rate and to sidestep onerous reporting requirements.  And it definitely includes small cash-intensive businesses that prefer to get paid in cash so they can underreport revenues to tax authorities.  In some countries, like the United States, the underground economy very importantly includes firms that save on costs by hiring illegal immigrants at low wages, enabling them to undercut firms that hire workers legally.”

The data indicating the extent of tax evasion is startling.  One realizes that the tax authorities will target suspicious tax returns for an audit.  However, they can also target tax returns for an audit randomly in order to poll the economy to estimate the extent to which tax avoidance activities affect revenue.

“The IRS has used these extensive audits, combined with an array of other information (e.g., investigations into high-income-earner tax shelters) to arrive at an overall estimate of unpaid taxes.  For 2006, the most recent year reported, the IRS found that the “tax gap”—the difference between taxes voluntarily paid and taxes due—was $450 billion.  This comprises tax evasion in many different sectors, including underreporting of business income, wage income, and rental income.”

“Of the $450 billion, the IRS expected to recover $65 billion, leaving a net tax gap of $385 billion.  Put differently, roughly 14% of estimated 2006 federal taxes, or 2.7% of 2006 GDP, will never be paid.”

One might suspect that this activity goes on at levels where cash is not the logical means of transaction, but that would be wrong.  It seems a staggering number of small businesses use cash transactions as a means of hiding income.

“By far the most important area of tax noncompliance comes from underreporting of business income by individuals who conduct a significant share of their transactions in cash.  The problem extends to individuals operating as partnerships or small corporations.  Overall, small business owners report less than half their income and account for 52% of the tax gap.”

And the problem is even worse when state and local taxes are included.  Rogoff states that state and local taxes provide revenue at a level of about two thirds of federal revenue.

“Most states have income taxes (where noncompliance is presumably similar to that for the federal income tax), as well as sales taxes, where the scale for noncompliance in cash transactions is enormous.”

Rogoff uses the research of Gabriel Zucman to provide an estimate of the revenue lost to tax evasion utilizing offshore tax havens.

“In his 2015 book, The Hidden Wealth of Nations, University of California professor Gabriel Zucman has estimated that total financial wealth held in tax havens (including stocks, bonds, and bank accounts) amounts to about $7.6 trillion, or 8% of the world’s financial wealth of $95 trillion.”

The estimated loss of revenue to the United States from these tax havens is about $35 billion per year, and for Europe about $78 billion.  Surprisingly these numbers are much smaller than the sums involved in domestic tax avoidance activities.  However, Rogoff reminds us that cash and large-value bills are part of the scheme.

“These are large figures, but in comparison to overall tax evasion in the United States and Europe, they are only a modest fraction of the total.  In any event, even in the case of offshore tax havens, a considerable quantity of wealth still goes in and out in the form of paper currency packed in bags.”

The drug trade is probably the highest profile illegal activity that depends on cash for its transactions.  Rogoff provides an estimate of the size of the markets for cocaine, heroin, marijuana, and methamphetamine at a bit over $100 billion as of 2010.  He doesn’t claim that eliminating cash would eliminate the drug trade, but he does suggest that it would severely disrupt its business model.

“Given the violence and crime that the drug business spins off, the potential benefits to even a small reduction in drug trade crime arguably can have an extremely beneficial effect.”

A major problem for countries like the United States is the effort and expense involved in controlling their borders.  Rogoff points out that illegal immigration is a cash intensive business.  It takes cash to purchase a path across the border, and unreported cash wages paid to illegal immigrants often provide the economic motivation for making the crossing.  Limitations on the availability of significant amounts of cash would disrupt this business model and may be the most efficient way to limit illegal immigration.

“Yet there seems to be precious little awareness of how much more difficult and risky it would be for employers to routinely hire illegal workers if they could not pay in cash, and how phasing out paper currency might prove a far more effective remedy than the alternatives being considered.”

If one is to propose eliminating cash or making it scarce, it is necessary to produce numbers indicating how cash is being used in the legal economy.  Rogoff indicates that US dollars are of use to other countries and that as much as half the cash in circulation is held by foreign countries.  In terms of domestic use, the breakdown is as follows.

“A couple studies back in the 1990s that seed cash in retail establishments (e.g., in cash registers) is less than 2% of all outstanding cash, with perhaps another few percent in transit to banks at any one time.  Given the huge trend of decline in cash used for medium and large retail transactions over the past 20 years, this share can have only declined.”

“As of mid-February 2016, US currency in bank vaults and ATMs combined was $75 billion, which equals about 5% of reported currency in circulation.  However, out of this $75 billion, $61 billion is treated as required reserves, and doesn’t even count in the currency-in-circulation figures….”

“….the order of magnitude for consumer cash holdings is roughly 6-7% of total currency in circulation….”

Summing all these holdings for legal purposes suggests that 30-40% of outstanding US cash could be facilitating illegal activities.  

Rogoff has made his point that the currency supply could be restricted considerably without doing damage to our economy.  The obvious connection between illegal activities and high denomination bills has been long recognized and countries are beginning to do something about it.  The European Central Bank recently announced that it would no longer produce the 500-euro note.  Rogoff would start by phasing out $50 and $100 bills.  As this post was being written, this article was encountered: In Surprise Move, India Voids 500 And 1,000 Rupee Bills To Fight Corruption. 

A number of countries seem quite happy to begin phasing out cash transactions as a way to increase efficiency.  The chip and PIN cards common in Europe (and, hopefully, soon to become available in the United States) make all but the smallest cash transactions inefficient for both the consumer and the vendor.  Some bank branches in Sweden don’t handle paper currency at all.  Try finding an ATM in Stockholm.  Many businesses have begun to put up signs indicating that cash transactions are not allowed.

Younger people seem quite happy moving towards a low-cash future.  The older people who might already be suffering from a form of future shock better take note.  There is much more to come.