A More Modest Proposal

Does the United States need to provide a high-denomination “supernote” of $500 or $1,000? In a stimulating essay, J.P. Koning suggests that such a note, combined with a means to tax it, could improve economic outcomes. His proposal derives from his recognition that currency provides a flow of services by facilitating transactions that are valuable to society. Currency has a dark side, however, in its use as an untraceable way of evading taxes and prohibitions on criminal activities. Currency’s services are threatened by the steady onslaught of inflation that has eroded its value over time, effectively limiting the range of transactions, both good and bad, that it can best facilitate. In terms of its buying power, the $100 bill just ain’t what it used to be. Koning’s proposal to introduce taxed supernotes is a way both to arrest the erosion of currency’s services and to discourage excessive use of high-denomination notes.

Koning’s proposal has two parts. Rather than simply issue a new high-denomination note, the new note would be taxed. Let’s consider these two separate aspects of the proposal in turn: the introduction of the supernote and the taxation of high-denomination notes.

Koning provides a sound characterization of the services provided by currency in its transactions role: censorship resistance, data protection, and the ability to act as a backup for the global monetary system. These attributes allow currency to provide unique transactions services. If currency weren’t available, many transactions simply would be foregoneso providing currency is an important public service. With positive but low inflation in most of the advanced nations in recent decades, the real value of fixed nominal denominations has declined significantly, though gradually. The gradual reduction in real values, combined with the introduction of convenient credit and debit cards, allowed people to adjust to the lower value of particular denominations by using alternate means of payment.

Koning is nonetheless rightly concerned that the reduction in real value of current denominations may cause society to lose some of the benefits of currency. Again, if the largest U.S. note 50 years ago was seven times the value of today’s largest note in real terms, it is worth asking what we have lost or gained in the transition. To stop the inflation-induced reduction of services provided by currency, Koning suggests a bold remedy: introduce a high-denomination note. This could be something like the $100 bill of 50 years ago, equal in today’s dollars to a $500 or $1,000 note.

The suggestion that the U.S. introduce a $500 or $1,000 note draws our attention to an important question: what is the best system of denominations for U.S. currency? Relative to fifty years ago we have had the unprecedented development of credit and debit cards, the introduction of the internet and online banking, and more recently, innovations of convenient person-to-person mobile payments. All of these changes have certainly assisted people in substituting away from currency as its denominations have diminished in real value. Over the same period, however, the demand for currency and its services has risen as inflation and economic growth have tended to increase nominal transaction sizes, income inequality has widened, and the absolute number of people without bank accounts has grown. It is plausible that a denomination system with some higher denominations would provide a better match to today’s transactional demand for currency, although that proposition is far from certain.

The intention of a tax on high-denomination currency would be to reduce illicit and illegal activities. High-denomination notes are especially useful in currency’s illicit and illegal uses—a $100 note is a hundred times more valuable than a $1 note but is equally cheap to carry and store. This trait, along with the untraceability of currency, makes high-denomination notes more convenient for large transactions and for storing ill-gotten gains. A tax on high-denomination notes would tend to diminish their quantity demanded. People engaged in transactions that would otherwise use high-denominations notes would either forego the transaction, or find some less convenient workaround, using another means of payment, such as cybercurrency.

All currency is subject to an implicit tax, since currency earns no interest and suffers a reduction in value from inflation. Koning proposes adding an additional tax on supernotes by issuing them at par and redeeming them for lesser amounts. For example, it would cost $1,000 to obtain a $1,000 note, but whenever in the future the note would enter the banking system, it be redeemed for something less than $1,000, depending how long it has circulated.

Taxing high-denomination notes has significant drawbacks. First, the specific form of taxation that Koning suggests, namely a lower redemption value over time, assessed whenever a note enters the banking system, relies on market participants to correctly gauge and enforce the current value of the note. That calculation is a difficult one in the decentralized circumstances in which cash transactions occur. It is also unlikely that the tax would be widely enforced as currency changes hands in decentralized transactions, especially in circumstances in which there is coercive power on one side of the deal, something that is common in illegal activity. Furthermore, note-holders could simply avoid depositing the notes in the banking system for years and years, thereby effectively avoiding the tax.

It is important to state that a tax on high-denomination notes is not a Pigouvian tax, one that taxes a noxious activity, such as imposing an excise tax on the output of a factory that creates pollution. Instead, it is a tax on an input to activities, only some of which may be noxious. That is akin to taxing the labor that could be used in the polluting factory or in a nearby nonpolluting garden. Taxing inputs that can be used for good or bad purposes will regrettably impose taxes on some good uses of the input, in this case high-denomination notes.

The combination of a high-denomination supernote and a way to tax that note is an intriguing proposal, as it attempts to reckon with both the falling real value of currency and the service that high-denomination notes provide to some tax-evasion and criminal activities. Whether a supernote is warranted is difficult to determine, but to introduce a $500 or $1,000 note would represent a relatively dramatic change in the current denomination structure and would require more convincing evidence than we have at present. Taxing different denominations differently would tax beneficial uses of currency along with the unsavory ones, and the form of the proposed tax makes it unlikely to be widely enforced in practice. Perhaps an alternative proposal with the same goals as Koning’s would be to introduce a $200 denomination note, and to increase expenditures devoted to detecting violations of our nation’s laws and on enforcement of those laws, especially those related to money-laundering, tax evasion, and terrorist funding.

Also from this issue

Lead Essay

  • J. P. Koning looks at the world of high-denomination currency. Per American, there’s way more of it in circulation than even very rich Americans typically see. Much of it is undoubtedly used in crime and under-the-table transactions, which escape the tax system and impose in-effect taxes on the rest of us, who must make up the shortfall as fraudsters evade taxes. Koning proposes to issue high-value notes that would gradually depreciate as a way of tackling this tricky problem.

Response Essays

  • James McAndrews suggests that issuing paper money with a high but gradually decreasing value might not work out well. The demand for high-value paper is large, but much of it comes from illicit enterprises, who might be willing to use force to extract value from their clients. Confusion could lead to disuse at best and to fraud at worst. But the $100 bill isn’t worth what it used to be, and in response he suggests issuing a $200 bill.

  • Joshua R. Hendrickson says that maybe high-denomination notes aren’t creating externalities in the proper sense of the term. The fact that some people don’t like off-the-books transactions does not mean that they impose actionable costs on bystanders. But if we grant the claim for the sake of argument, then a two-tiered currency with depreciation of higher-denomination notes would indeed be wise.

  • William J. Luther argues that we shouldn’t tax currency at all. We should modestly reward holding it, through a bit of deflation. Luther doubts the extent of tax evasion and other crimes committed though the use of cash. He also argues that many prohibited uses of cash, including off-the-books employment, are ubiquitous, harmless to others, and do not merit any punishment or disincentive.