Tag Archives: Tax evasion

Reserves for Everyone—Towards a New Monetary Regime?

In the first and third of his Munich Lectures in Economics (and in an earlier oped in the FT), Kenneth Rogoff argued in favour of phasing out cash, at least high denominations and in some developed economies, see my post. Rogoff emphasised two beneficial consequences. First, the abolition of the zero lower bound on nominal interest rates and thus, the relaxation of a constraint on monetary policy. And second, the abolition of a means of payment that guarantees anonymity and thus, facilitates criminal transactions, money laundering, tax evasion and the like.

Both Rogoff and other academics have discussed the topic before. More than in academic papers, the end of cash has been the subject of intense debate in the blogosphere. By far the clearest discussion I know (and a very comprehensive one) is due to Willem Buiter in a blog post I summarise here. But the list of authors that have contributed to the discussion is much longer. Here is a selective overview:

As far as solutions to the zero lower bound problem are concerned, Buiter in his post referred to several academic contributions, namely Eisler (1932), Goodfriend (2000), Buiter and Panigirtzoglou (2001, 2003), Davies (2004) and Buiter (2004, 2007). Rogoff in his lectures referred to Silvio Gesell as well as writers in the blogosphere including Mankiw, Buiter and Kimball.
Concerning the loss of tax revenue due to anonymous currency holdings, Rogoff referred to his own earlier work (Rogoff 1998).
On April 19, 2009, Gregory Mankiw discussed the zero lower bound in the New York Times. He reported a proposal by a graduate student to relax the bound by taxing currency: The Fed should announce that all notes whose serial number ends in a particular digit would cease to be legal tender within a certain time period; and the digit should be determined by a lottery. (According to Buiter, Charles Goodhart made the same proposal earlier.)
On May 7 and 19, 2009, Willem Buiter strongly argued in favour of negative nominal interest rates in his FT maverecon blog (see my post). He identified currency’s status as a bearer security as the cause of the zero lower bound and discussed three strategies to relax the bound: Abolishing currency; taxing it (difficult); and separating the medium-of-exchange role of money from the unit-of-account function by creating a unit of account dollar (think of reserves) on the one hand and a medium of exchange dollar (think of currency) on the other. The former would pay positive or negative interest, the latter would pay no interest. Both would trade at an exchange rate, and interest parity conditions would hold in equilibrium.
Other FT bloggers took up Buiter’s proposal. An early post, on May 20, 2009, is due to Izabella Kaminska in FT Alphaville.
On April 19, 2012, Matthew Yglesias argued in Slate that the abolition of the zero lower bound would facilitate expectations formation about monetary policy.
On November 5, 2012, Miles Kimball took up the issue in a blog post. In another post, he discussed Marvin Goodfriend’s (2000) contribution to the debate.
On April 15, 2013, Izabella Kaminska suggested in FT Alphaville that direct access of consumers and investors to government provided electronic money would allow central banks to bypass commercial banks, improve the monetary transmission mechanism and help end a shortage of safe assets.
On April 16, 2013, Jean-François Groff argued in FT Alphaville that electronic money should be provided by the government instead of private companies (“digital legal tender”). Governments then could (re-)gain seignorage and consumers would benefit from lower fees and user costs.
On July 27, 2014, John Cochrane discussed Sheila Bair’s opposition against letting the broader public hold reserves. On August 21, September 17 and September 22, 2014, he approvingly discussed (here, here and here) the Fed’s balance sheet policy from a financial stability/narrow banking perspective (see my post on narrow banking proposals). On November 21, 2014, he interpreted minutes of an FMOC meeting as suggestive evidence of plans to establish segregated cash accounts.

When evaluating the merit of these discussions, it is important to distinguish between (i) introducing government provided electronic money and (ii) doing so in combination with an abolition of currency. Consider first the former option, namely to have the government grant the broad access to central bank reserves. This could be useful as it opened up the possibility to eliminate the risk of bank runs and as a consequence, abolish the fragile and costly system of deposit “insurance.” If, that is, most savers opted to move their deposits to the central bank rather than keeping them with commercial banks. If they didn’t, then governments would most likely feel obliged to continue bailing out depositors in failing commercial banks.

Another advantage of introducing government provided electronic money would be to eliminate a disgraceful contradiction in public policy. Mostly for reasons related to the deterrence of tax evasion, governments increasingly force citizens to use electronic means of payment although these are not legal tender and declare the use of currency illegal although currency is legal tender. In effect, governments force citizens to use liabilities of private companies for their transactions and in doing so, expose citizens to various financial risks. (These risks are partly borne by the public sector, due to deposit insurance, but that insurance creates other problems.) This absurd situation would end if the government provided a legal tender for electronic payments.

But granting the public access to central bank reserves could also create new problems. Inducing savers to move their deposits from commercial banks to the central bank would undermine a central activity of the former, namely deposit financed credit creation. Douglas Diamond and Philip Dybvig (1983) have shown in a classic article that the insurance characteristics of a deposit contract help improve outcomes relative to a situation without such a contract. How large are those benefits? And how large are they relative to the social costs of bank deposits, namely inefficiencies due to deposit insurance (moral hazard) and costs of run-induced fire sales and defaults?

There are other open questions. One concerns the transition from the current system where savers hold deposits at commercial banks, to a new system where they hold central bank reserves. Would the central bank assist commercial banks and convert deposits into reserve holdings? And if not, how could runs be avoided?

In addition, questions of a more technical nature would have to be addressed. Should banks (in the interbank market of reserves) and the general public (when paying their bills) use the same payment system? Or should the existing system linking the central bank and commercial banks be kept separate from a new, to be designed, system that serves consumers? How would monetary policy in this new world look like and how would the monetary transmission mechanism work? Would the central bank lend funds to households, and would it set the same policy rates for banks and the general public?

Turn next to the more ambitious proposal, namely to augment the introduction of government provided electronic money with an abolition of currency. This suggestion is more problematic, because the promised benefits are likely overstated and the costs misjudged. Consider first the benefits. As far as the relaxation of the zero lower bound is concerned, the fundamental objective—to lower real interest rates in order to incentivise earlier consumption and investment—cannot only be achieved through monetary policy but also by tax policy. A trend increase in consumption or value added tax rates acts like a low or negative real interest rate. And even if the objective is to relax constraints on monetary policy rather than relying on fiscal policy, this is feasible without eliminating cash altogether (and without moving to a higher inflation target which is costly for other reasons). As explained by Buiter, all that is needed is a floating exchange rate between reserves and cash. Killing currency amounts to an overkill unless one fears negative consequences due to such a floating exchange rate (see, e.g., Goodfriend, 2009, fn. 23).

As far as the second objective—limiting tax evasion as well as criminal and black economy transactions—is concerned, the elimination of currency is not a sufficient measure. True, those seeking anonymity would need to incur additional costs to secure it. But these additional costs would likely be mostly fixed costs (e.g., fees for incorporating a shell company in Nevada and hiring a lawyer). The implicit tax on black market activity due to the abolition of currency thus would be a regressive one and the revenues it generated would likely be smaller than hoped for. Professional criminals directing large operations could easily afford the higher cost of securing anonymity while the tax dodging middle class plumber in a badly run country could not.

Turning to the disadvantages, eliminating currency has severe consequences for privacy. (Buiter’s suggestion of ‘cash-on-a-chip cards’ could limit those consequences somewhat.) This point is widely acknowledged in the debate but it is not given sufficient weight. Related, forcing savers to hold means of payment—and a significant share of their savings—exclusively with a branch of the government (the central bank) might cause concern, particularly in countries with a history of expropriation.

Finally, there is a completely different reason to be worried about the prospect of putting an end to currency; when pointed to the proposal under question, some mothers I talked to immediately articulated it: In a world without physical money it is harder to acquire basic financial literacy skills. This might appear like a third-order problem, but is it?

Phasing out Cash

In the first and third of his Munich Lectures in Economics, Kenneth Rogoff argued in favour of phasing out cash, at least high denominations and in some developed economies. (His second lecture covered financial crises, see my post.)

Rogoff is well aware that cash preserves privacy and he acknowledges that one should have very good reasons to advocate phasing it out. He believes that there are two: Tax evasion and the black economy on the one hand, and the zero lower bound on nominal interest rates on the other.

Based on earlier research (Rogoff 1998) he argues that withdrawing bank notes with high denominations (e.g., USD 100 bills, EUR 500 bills etc.) would increase the cost of evading taxes or engaging in the black economy sufficiently strongly as to raise tax revenues, and that increased tax revenues would more than compensate for any loss of seignorage.

The (close to) zero lower bound on nominal interest rates and the resulting constraints for monetary policy derive from the fact that cash pays a zero nominal interest rate. Rogoff emphasised the seminal contribution of Lebow (1993 Fed working paper) in identifying the problems connected with the zero lower bound as well as possible ways to address them. Rogoff added that earlier writers (e.g., Gesell, Goodfriend, Mankiw or Buiter) who suggested to relax the constraint by subjecting cash to depreciation missed the point. Rather than forcing a negative nominal interest rate upon cash one should eliminate it altogether. He also dismissed shifting to a higher inflation target to avoid the zero lower bound problem, pointing to the huge loss of credibility that central banks would suffer as a consequence. Among factors for the trend towards lower real interest rates, Rogoff emphasised demographics and the asset pricing consequences of rare disasters; he dismissed secular stagnation. He also discussed forward guidance in the form of price level targeting.

Rogoff suggests to replace cash by universal debit cards. He does not expect significant technical difficulties in the process and proposes to subsidise debit cards for low income households.

Corporate Taxation, Profit Shifting and Cross-Border Tax Avoidance and Evasion

Matthew Klein discusses corporate and personal income tax evasion and avoidance in the FT (part 1, part 2), with reference to a JEP article by Gabriel Zucman. Klein makes several points:

Profit taxes were introduced as complements to income taxes, in order to make it more difficult to evade taxes by routing profits through fabricated corporate structures rather than distributing them. To avoid double taxation, capital gains and dividends typically are taxed at lower rates than labor income.
Whether corporate taxation should be coordinated internationally is not a new question. The League of Nations already debated it. The issue regained importance as international trade and cross-border profit flows rose.
Today, a third of US corporate profits are generated outside of the US. Of those, more than half are generated in Ireland, Luxembourg, the Netherlands, Singapore, Switzerland and the Carribean. Both shares have increased over recent decades (see the figure below which is taken from Zucman’s article). This might have contributed towards lowering the effective corporate tax rate of US corporations in the US.
If the objective is to (i) avoid double taxation and (ii) render cross-border profit shifting irrelevant, an easy way forward could be to credit a corporation’s taxes paid worldwide against the personal income taxes owed by the corporations shareholders. This would imply that higher corporate taxes abroad could lead to lower domestic income tax revenue, a difficult political sell. It would also imply that unrealised capital gains may go untaxed.
Based on discrepancies between national balance of payments statistics, Zucman estimates that 8% of global household financial wealth is not reported to tax authorities (see the table below which is taken from Zucman’s article).
He proposes to impose high tariffs on exports originating from “tax havens” to force these countries to exchange information about bank accounts and, in the medium term, to create an “international financial registry.”

The End of Bank Secrecy?

Jeevan Vasagar and Vanessa Houlder report in the FT about the pledge by 51 countries to facilitate the collection and exchange of information on bank accounts and the beneficial ownership of companies and other legal structures. The agreement was drawn up by the OECD and previously endorsed by the G20. Going forward, the countries involved seek a consensus on the treatment of intellectual property income.

Christoph Eisenring in the NZZ and the FAZ provide additional information. Liechtenstein, Luxemburg, Bermuda, the British Virgin Islands and the Cayman Islands signed the accord; Switzerland and Singapore promised to follow soon; Panama and the US didn’t. German finance minister Wolfgang Schäuble declared the end of bank secrecy. While not signing the agreement the US is credited for helping to make it possible, due to the FATCA treaties is has signed with many countries. Those treaties also stipulate an automatic exchange of tax information. However, so far the US has not produced the legal base to provide such information to foreign governments.

Options for British Tax Evaders to Come Clean

hus in the NZZ writes about options for British tax evaders to come clean about hidden financial assets abroad.

UK residents with Swiss assets who do not want their identity to be disclosed to the British authorities can pay taxes on their asset holdings to the Swiss authorities instead; the Swiss will (partly) hand them over to London. The relevant treaty between the UK and Switzerland was put into effect in 2013.

UK residents often prefer an alternative option, though, namely to “legalise” their world wide asset holdings using a treaty between Liechtenstein and the UK. According to that treaty, assets fully declared before the end of 2016 trigger a penalty of about 10% to 20% of the relevant asset holdings, as compensation for evaded taxes in the past. British tax payers can use this option as long as the fraction of their offshore assets that they invested in Liechtenstein is sufficiently high.

“Timing Tax Evasion,” JPubE, 2005

Journal of Public Economics 89(9-10), September 2005. PDF.

Standard models of tax evasion implicitly assume that evasion is either fully detected, or not detected at all. Empirically, this is not the case, casting into doubt the traditional rationales for interior evasion choices. I propose two alternative, dynamic explanations for interior tax evasion rates: First, fines increasing in the duration of an evasion spell, implying that the expected costs of evasion increase convexly with the time spent non-reporting, while the benefits increase linearly. Second, different vintages of income sources subject to aggregate risk and fixed costs when switched between evasion states. The dynamic approach yields a transparent representation of revenue losses and social costs due to tax evasion, novel findings on the effect of policy on tax evasion, and a tractable framework for the analysis of tax evasion dynamics.

Dirk Niepelt

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