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.